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Escaping the Eurozone: Grading the Wolfson Prize finalists

The 2012 Wolfson Economics Prize theme is how countries can depart the Eurozone.

Lord Wolfson’s vainglorious economics prize for 2012 will be awarded to the best solution for an orderly exit from the Eurozone.

The five finalists are:

  1. Roger Bootle from Capital Economics;
  2. Cathy Dodds, engineering graduate from Oxford University;
  3. Jens Nordvig and Nick Firoozye from Nomura Securities;
  4. Neil Record of Record Currency Management; and,
  5. Jonathan Tepper, chief editor of Variant Perception.

All five get a guaranteed £10,000 share of the prize money, with the winner receiving £25,000.

Quiet please. We’re grading papers here. Remember, the decision is final and no judge shall be entered into.

*What do they argue?*

For *Roger Bootle* from Capital Economics, “The euro is a malfunctioning monetary union that was put together for political reasons”. He posits that monetary union should be undone, and Germany should leave the Eurozone with what used to be called the Deutschmark Zone. Not very likely, he concedes. Bootle says this that defaulting countries (like Greece) could effect temporary capital controls and redenominate national debt in a new currency (like a neo-drachma), boosting exports when it falls, inevitably, by 50% against the euro.

Verdict: Old hat. The usual catch-cry of ‘weaker-currency-cheaper-exports’. Exports of what? Greece doesn’t manufacture BMWs, Bosch appliances or engage in Airbus aeronautics. And who the hell would trust a ‘new’ drachma? No one even wanted the old one. Capital controls? How? Greek residents have been sending their euro out of the country ever since this crisis began. They’ve withdrawn at least €75 billion from the Greek banking system in recent months. That money is either stuffed in the mattress, studiously avoiding tax, or in Switzerland. *Grade: C–*

*Cathy Dodds*: Complicates the situation by dividing the Eurozone into two – or possibly more – regions (broadly speaking, ‘core’ Northern Europe and the ‘peripheral’ south, each with its own central bank, currency and monetary policy. The Euro would be abolished, ultimately, with a new currency unit based on a basket comprising the regional currencies.

Darkness at noon: European Central Bank HQ in Frankfurt.

Verdict: Mind-boggling complexity. More new currencies? More central banks? More monetary policies? If you want to see how this works, take a glance at eastern Europe’s non-members of the Eurozone. Last time I looked, Hungary, Poland and the Czech Republic were not travelling at all well. In March, the EU froze almost half a billion euro in funds payable to Budapest due to Hungary’s chronic budget deficit. And Budapest isn’t even in the Eurozone. Quite apart from this, German, French and Italian business own most of eastern Europe’s industrial productive capacity. Moreover, as long as you have an EU, you have to have a general unit of account for the EU General Budget and Common Agricultural Policy transfer payments. From 1950 until 1971, this was the European Payments Union, that introduced the European Unit of Account (EUA). This was replaced by the European Currency Unit (ECU) until 1999, which saw the introduction of the Euro. The point here is that the euro gives the ‘core’ EU greater purchasing power in the ‘peripheral’ EU. And that keeps peripheral Europe peripheral. Which is how western Europe likes it. *Grade: D.* Must. Try. Harder.

Jens Nordvig and Nick Firoozye: A country departing the Eurozone would still find itself laden with contracts denominated in euro. There are extant EU foreign debt contracts (i.e., contracts that are not written within the legal jurisdiction of the debt-issuing country) that total over €10 trillion. Nordvig and Firoozye recommend that Eurozone defectors redenominate debt that falls within the jurisdiction of national law in a new currency. In a less complicated version of Dodds’ solution, the Nomura Securities analysts suggest that debt under foreign law contracts should be reissued in European Currency Units (ECUs), based upon a country’s share of a weighted basket of currencies.

Verdict: Slightly better, but still riddled with problems. Banks with euro contracts would invariably get all lawyered-up and sue within their domiciles, arguing that the debt must be repaid in euro, and they would likely win in court. In addition, neither Dodds nor the Nomura analysts address the question of the 25% of all global foreign exchange reserves that are held in euro. What happens to offshore euro once you abolish the currency? Don’t even get me started on currency runs once the markets get wind of the abolition plan. And they will. Grade: B-

Neil Record of Record Currency Management writes of the need for Germany and France to form a “secret task force”, abolish the euro currency and replace it with new national currencies. Germany, Record argues, “must propose that it unilaterally breaks away from the euro, establishes its own national currency, severs its links with the ECB and takes no further part in the resolution of the euro crisis.”

Germany benefits enormously from a weaker euro.

Verdict: Sorry Neil, but I’m not putting my money in your Currency Management. First, Germany is a free rider on the euro: it’s undervalued, while the pre-2002 DM was overvalued, hurting German business and exports. Why in the world would Berlin want to abandon the euro? There are reasons why Frau Merkel is prepared to bankroll this project. Second, I don’t know whose thumbs Neil was twidling during the 1992 and 1993 EU currency crises, but he is clearly clueless about what happened when a bunch of forex speculators dramatically ‘broke the Bank of England’. Two words, Neil: George. Soros. Grade: F.

Jonathan Tepper looks at previous currency breakups. Like Czechoslovakia, the USSR, Pakistan-Bangladesh and the Austrian Empire. Plus a whole bunch of countries in Africa and elsewhere that became independent of their colonial masters after World War II. These all went smoothly, according to Tepper. So if Greece, Portugal and Spain exit the Eurozone, they would default and become more competitive by introducing a new currency.

Verdict: Hmm, Czechoslovakia, USSR: non-convertible currencies. And when the Czech and Slovak Republics split, two-way trade fell and they both ran down their foreign reserves. Slovakia is in the Eurozone (since 2009); the Czech Republic is still slated to join in 2013. Pakistan-Bangladesh? Smooth split? If that’s what you call a civil war with over a million dead. Austrian Empire? World War I. Then Austria went bust in 1931 and Nazism gained popularity. In 1938, Austria ceased to exist. Very smooth. African colonies? The former French colonies’ currencies would be worthless if they weren’t backed by the CFA franc zone. Yes, and the euro is being used in the Caribbean as we speak. Do we really have to grade this? OK, E-

None of these solutions can be achieved quickly and with the minimum of economic and monetary dislocation. Most of them are also centred around some type of currency manipulation scheme, like the one Washington so deplores about Beijing. When West Germany underwent currency reform in 1949, it swapped the old Reichsmark 10:1 for the new Deutschmark (DM). In 1990, when East and West Germany unified, the Bundesbank accepted up to 4,000 East German marks at 1:1 exchange and 2:1 for larger sums. Yes, the German central bank exchanged the strong DM for essentially worthless paper from a socialist state that had just been abolished.

The deutschmark making a comeback? Not likely.

The point here is that 1949 and 1990 were both clean-sheet operations. The Eurozone itself took almost 10 years to construct (although it really started to evolve in 1972). Currency unions are not made and broken overnight. Not without castastrophic consequences they aren’t.

And the winner is … None of them. And these sundry economists and consultants have too much time on their hands if they can waste it writing essays on a hypothetical scenario for Lord Wolfson’s vanity project. Frankly, Edward Hugh’s post is better (scroll down for Athens University’s Yiannis Varoufakis’ opinion, which is the most sane piece of analysis out there). Varoufakis argues,

“All that it would take to allow Greece to stay in the eurozone, in a better state than it is today (and less austerity for that matter), is the continuation of the present ECB policy toward Greek banks…As for those who argue that the ECB will take an aggressive stance, think again: The ECB will not knowingly take steps which will destroy the eurozone.”

Damn straight. The envelope, please. Congratulations, Yiannis. You are our 2012 Wolfson Winner. Here’s your 25,000 drachma prize…

P.S. If you’ve read this far, you’re probably interested enough to read a book on how the euro got started. For an insider’s account, see Bernard Connolly’s The Rotten Heart of Europe (1995).

Disclosure: Remy Davison is a Director of a Centre that receives funding from the European Commission.

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