What if they did come back...?

Dedicated to those who believe national currencies might solve all problems.


To leave or not to leave? All things considered, it's probably better to stay, despite all the problems afflicting the premature project, instead of putting the boat out towards shores that right now might harbour the beginning of the end rather than a fresh start. This is the dilemma faced by the eurozone.

A return to national currencies, be it the drachma or the lira, is currently being floated by populist political parties to woo citizens and deceive them into thinking that an alternative to structural reform is there for the taking. Marine Le Pen's National Front in France and Matteo Salvini's Northern League in Italy keep the hype rolling, but they don't do their math. To understand what might happen, in an extremely hypothetical scenario, we must first look at the European treatises. Because it is crucial to remember that Article 50 of the Lisbon Treaty stipulates that a member state may withdraw from the European Union, but not from the eurozone. In other words, a nation must first leave the EU before it can it drop the single currency.

In such a case, however, the seceding country would no longer be able to take advantage of the Schengen Agreement or the European Common Market. Meaning that there would no longer be free circulation of people or goods for that country. 

In such a case, however, the seceding country would no longer be able to take advantage of the Schengen Agreement or the European Common Market. Meaning that there would no longer be free circulation of people or goods for that country. International trade would be destabilized and probably blocked for months, as the Swiss bank UBS has pointed out, unless other economies were to come to the rescue.

The impact on individual states is difficult to predict. According to Éric Dor, head of economic research at the IÉSEG School of Management, if Greece were to pull out, the greatest costs would have to be shouldered by three countries, along with Athens naturally. The worst consequences would be borne by Germany, which stands to lose around €56.5 billion, or €699 per resident. France would follow with a total cost of €42.4 billion, or €644 euro for every French resident; and lastly, Italy with some €37.3 billion.

We could expect the heaviest repercussions in the banking sector. A country leaving the eurozone would lose the protective umbrella of the European Stability Mechanism (ESM) and would be forced to set limitations to the free circulation of capital. In other words, it would have to set a ceiling on cash withdrawals and introduce measures to avoid capital taking flight towards safer shores. The underlying concept is linked to the behaviour of the economic agents. The greater the risk a country or a banking system represents, the more people who wish to protect their capital will try to move it elsewhere. This is known as the fly-to-quality mechanism.

Moreover, a country that decides to leave the eurozone loses the support of the European Central Bank (ECB), which is a crucial mainstay, as Greece is proving. The National Bank of Greece is, in fact, resorting to the ECB’s emergency liquidity assistance (ELA) to supply its banks with fresh resources. A country outside the eurozone would not be entitled to do so and would therefore have to cover any losses of its banking system directly.

How would it do this? There are two plausible and readily implemented options: by printing currency, thereby incurring the risk of fuelling inflation and reducing citizens’ buying power, or by negotiating foreign currency swaps with other central banks in an attempt to cut losses. Moreover, the euro would be considered a foreign currency and thus have a very different swap rate from the one introduced in the country that has left the eurozone.

There would also be the problem of recalculating the existing contracts signed before secession. Even once it was out of the eurozone, the country would still be required to pay back the old treasury bonds issued according to international regulations in the earlier currency (which in the case of Greece would be most of them, according to UBS estimates).

And as for government bonds, the same would hold true for all contracts between private companies. Unless there's a unilateral decision, which would in all likelihood be disputed by those likely to lose them, this means the contracts can be honoured in the new currency rather than the old one, which would result in a significant cut in equity. And would lead to devaluation.

Let’s take Greece once more as an example. According to analysts at Goldman Sachs, the devaluation of the drachma against the euro could be around 40-50% in the first year alone and drop to around 30% from the second year onwards, for some ten years. The loss of buying power, added to the greater purchasing costs for essential goods, would force the country’s central bank to introduce measures to protect the new currency from interest rate fluctuations. This is essentially what is happening in Ukraine with the hryvnia.

While it is easy to talk about leaving the eurozone without mentioning implicit and explicit costs, irrationality must not get the better of rational deliberation. Leaving a monetary system that, despite its many shortcomings, has generated well-being even for those countries that were fighting recession by expanding the monetary base, and thus of inflation, means heading off into unchartered territory.

In 2008 it was said that the collapse of Lehman Brothers, the then fourth-largest US investment bank, was unlikely to have any significant impact on the international financial system. Two days after it went bankrupt, everyone understood that this was not the case. One hopes that even Le Pen and Salvini realise this when they talk of leaving the eurozone. 

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