Tuesday, January 3, 2012

Process of Leaving the Euro Currency Block

Many people are convinced that some euro zone countries will have to change to their own country specific currency. They all acknowledge that doing so would be expensive and have cause an international economic downturn. One of the commentators who I watch, John Mauldin (who is better than some, but far from excellent), quoted a private newsletter from the Boston Consulting Group, written by Dan Stelter. Mr. Stelter set out the steps that a country would have to take to exit the euro. They aren’t pretty and smack of totalitarianism: complete control of private assets. I have set these steps out below.

Note that there is already significant outflows of capital from all of the poorly performing euro countries, i.e., Greece, Spain, Ireland, and Portugal. If you have funds or assets there, including through mutual funds, consider moving them to somewhere that safer. There really is no safe place for large amounts of assets. Just keep the overall and the country specific issues in mind.

Steps for a country to stop using the euro and introduce a new currency:

Announce and immediately impose capital controls.

Impose immediate trade controls (because companies would otherwise falsify imports in order to get their money out).

Impose immediate border controls (to prevent a flight of cash).

Implement a bank holiday (to stop citizens from withdrawing their money and running before the devaluation) and although this is somewhat hard to imagine stamp every euro note in the country, converting it back to the national currency.

Announce a new exchange rate (presumably not floating at the beginning, given capital and exchange controls) so that trade could continue.

Decide how to deal with existing outstanding euro-denominated debt, which would probably entail a major government and private-sector debt restructuring (that is, default). This might be easier in the case of government debt, which tends to be governed by domestic law, in contrast to the debt of major corporations, which is normally governed by U.K. law (but we would assume enactment of laws declaring a haircut here, as well).

Recapitalize the (insolvent) banks to make up for losses from defaults.

Determine what to do with the non bank financial sector, the stock and bond markets, and every company account and commercial contract in the country.

Any breakup would lead to significant turbulence in financial markets just think about the number of credit default swaps outstanding and a worldwide recession. The OECD has warned that a breakup of the euro zone would lead to "massive wealth destruction, bankruptcies and a collapse in confidence in European integration and cooperation," leading to "a deep depression in both the existing and remaining euro area countries as well as in the world economy."

According to UBS, the economic costs of a breakup would be huge. Depending on whether the country leaving the EU is a "weak" or a "strong" country, the costs would range from Ä3,500 to Ä11,500 per inhabitant per year. Besides these implications for the countries of the euro zone, the world economy would be severely affected, with negative implications for the U.S. amplifying existing recessionary and potentially deflationary pressures and also for the emerging markets that depend on exports to the West.