Planets crash into dust. I just let it fade away.
Many economists expect catastrophic consequences if any country exits the euro. However, during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises. Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable.
Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).
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The breakup of the euro would be an historic event, but it would not be the first currency breakup ever. Within the past 100 years, there have been sixty-nine currency breakups. Almost all of the exits from a currency union have been associated with low macroeconomic volatility. Previous examples include the Austro-Hungarian Empire in 1919, India and Pakistan 1947, Pakistan and Bangladesh 1971, Czechoslovakia in 1992-93, and USSR in 1992.
Previous currency breakups and currency exits provide a roadmap for exiting the euro. While the euro is historically unique, the problems presented by a currency exit are not. There is no need for theorizing about how the euro breakup would happen. Previous historical examples provide crucial answers to: the timing and announcement of exits, the introduction of new coins and notes, the denomination or re-denomination of private and public liabilities, and the division of central bank assets and liabilities. This paper will examine historical examples and provide recommendations for the exit of the Eurozone.
The move from an old currency to a new one can be accomplished quickly and efficiently. While every exit from a currency area is unique, exits share a few elements in common. Typically, before old notes and coins can be withdrawn, they are stamped in ink or a physical stamp is placed on them, and old unstamped notes are no longer legal tender. In the meantime, new notes are quickly printed. Capital controls are imposed at borders in order to prevent unstamped notes from leaving the country. Despite capital controls, old notes will inevitably escape the country and be deposited elsewhere as citizens pursue an economic advantage. Once new notes are available, old stamped notes are de-monetized and are no longer legal tender. This entire process has typically been accomplished in a few months.
The mechanics of a currency breakup are surprisingly straightforward; the real problem for Europe is overvalued real effective exchange rates and extremely high debt. Historically, moving from one currency to another has not led to severe economic or legal problems. In almost all cases, the transition was smooth and relatively straightforward. This strengthens the view that Europe’s problems are not the mechanics of the breakup, but the existing real effective exchange rate and external debt imbalances. European countries could default without leaving the euro, but only exiting the euro can restore competitiveness. As such, exiting itself is the most powerful policy tool to re-balance Europe and create growth.
artwork { Victor Castillo }
