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How Greece could leave the euro


Thanks to a flaw in the design of the Euro, Greece could leave the eurozone without much technical or legal complications. Indepently from whether or not it would be beneficial for Greeks to leave the euro, this blog post looks into the design of the eurozone and reveals the flaw that would allow Greece to leave the euro and return to the drachma.

Sometimes a cool down period is necessary when engaging in a subject as sensitive as the Tsipras/Eurogroup debacle of last week. Especially so when expressing a critical view on Syriza. Now, some days have passed and many of the passionate bloggers, writers, facebookers and other social networkers have redirected their focus on other matters. Indeed, what more to write about the bailout agreement that Alexis Tsipras signed on July 16th? Practically everything has been already said in their defense, and practically every imaginable indictment has been pronounced.

However, at this point of the crisis of the euro, we Europeans might want to ask ourselves: is there a life beyond the euro? And perhaps more specifically: Is it possible to leave the euro peacefully and without descending into the chaos that is promised to us from Brussels?

Most people believe the euro is a single currency. This is in fact incorrect and the consequences of this are incredibly important. A short yet technical explanation of the Eurosystem, the system by which the euro is regulated, will allow us to see how Greece could indeed easily exit the euro without enduring the inherent difficulties of regular monetary unions.

 

The myth of the Euro as a single currency

While most people believe that the euro is a single or even a common currency — due mostly to the fact that the media call it like that — meaning that each and every euro would be a credit on the European Central Bank (ECB), who in turn issues banknotes and coins, the fact of the matter is that this is a myth.

This myth has been kept alive mostly through confusion and the complexity of the matter. Evidently, no one, including yours truly, without the following explanation could understand how the european monetary system works merely by reading the press, even the business section.

I, for one, could never have reached the conclusions that I will present here without the assistance and teachings of former ECB and French economist Vincent Brousseau, who spent 15 years in Francfort before he quit and became a full-time dissident of the euro and the EU. This complexity combined with the timid efforts of the ECB in its pedagogy, explains also why journalists, politicians and even activists specialized on economic issues miss the point when speaking about the euro and the eurosystem. I was no exception before I accidently ran into this expertise and could later confirm it by reading the corresponding legal texts and by consulting other specialized sources.

 

How monetary systems work elsewhere around the world…

In more conventional economies, i.e single nation currency areas (whereas the eurozone is a plurinational currencies area) which are defined according to national borders — like today’s Japan (Yen), USA (US Dollar), Switzerland (Switz Franc) or any European country before the euro (the Peseta in Spain, Franc in France…) — the currency in question is a unit of payment that the laws of that country oblige by law anyone within it to accept as valid payment and according to the given rate of exchange.

Also this unit of payment is a credit on its central bank. What this means is that a US dollar is a credit on the Federal Reserve Bank and a Swedish Cronor is a credit on the Riksbank. (This does not happen directly, but simply because commercial banks need to open accounts at the central bank in proportion to how many deposits they have. So each commercial bank has its own account at the corresponding central bank).

It means that if you have an account at the Bank of America in Austin, this bank will then have a corresponding account at the Fed. In other words, your dollars on your bank account are credits at the Central Bank of your country. It is money that the central bank of your country owes you, even if you went to a private bank to open an account and never set foot at the central bank’s headquarters.

That is how it works outside the eurosystem, in the “normal” world, so to speak. The explanation for what a currency is for traditional currency is relatively simple. The complexity, then on, of any given monetary system comes when dealing with other issues, mostly when going from monetary to financial issues. Other than that and for the purpose of this article is no more complicated than this.

Now, when it comes to the euro it is not exactly so and the design of the euro requires special attention for anyone wishing to understand these crucial matters with huge repercussions.

 

…vs the eurosystem

The eurosystem is not a single currency monetary system. It actually is a bundle of 19 different currencies (one for each European member state that adopted the euro) each with its own central bank but all under the same name and with a peg of 1/1, meaning a fixed exchange rate of 1 to 1.

Each individual bank account in these different types of euros are credits on its respective central banks, just like regular currencies are in the examples I mentioned above. The euros in Greek commercial banks are then a credit on the central bank of Greece just like any account in US Dollars is a credit at the Fed. What this means, de facto, is that there still is a French currency, called the (French) euro, an Italian euro, a Spanish euro, etc. and of course there still is a Greek euro. Indeed, they use the same name but they are credits at different central banks.

To add more complexity, there still are two more currencies that are part of the eurosystem: one is made of all the accounts at the ECB which are credits on the ECB and the other is made of all the banknotes which are all pro rata credits on every central bank in the system. What this means is that the laws of the Union force any central bank from any country within the eurozone to accept any given banknotes as if it had been issued by itself. It means that every banknote is in fact a credit on all the eurosystem together. This means that there is a sort of ‘forced’ solidarity between central banks.

The shorter definition for the euro understood as such is the following: the euro is a system of homonymous currencies — it means they have the same name — with an exchange rate of 1.

And just as Vincent Brousseau says: “this is a complex matter, but this is all there is to it. If you understand this you understand everything about the euro.” Indeed, understanding this is understanding everything, including its main weakness…

 

The vulnerability of the euro

The weak link in this system of currencies lies in the obligation, by law, for any central bank within the eurozone, to accept euros from another “currency”, meaning euros that would be credits from another central bank. This means, for instance, that the Banque de France is obliged by law to accept any “Spanish euros”, meaning that it can not refuse the flow of Euros that would be credits on the Banco de España.

This obligation is indeed the very definition of the european monetary union. It is the heart of the eurozone. In other words, to suspend this olibgation would be equal to ending the monetary union. So, to put it succintly: for Greece to leave the euro, it only needs to suspend this obligation and this exchange rate of 1. This means that this merely is a legal question that could be dealt with quite rapidly and without drama, just like when Greece adopted the euro 14 years ago.

 

A design flaw to the advantage of Greece

This system could have been thought of as any other monetary system preexisting the euro but it simply was not. The reason behind it is probably due to the Germans (not just them but mainly them) wishing to leave an emergency exit available in case the very neat and seemingly modern EU building caught fire and became the Towering inferno. The  people making the decisions in Berlin can be accused of many things, but one thing for sure is they are no mavericks.

What this means for Greece concretely speaking is that this eurosystem is, for lack of better words, a precut monetary system similar to those in children’s playbooks. The way it was designed makes it very easy for any government wishing to leave the currency: leave the eurozone by using art 50, suspend the obligation to accept euros indefinitely and depeg the currency.

All that I have described here above means that the drachma, in essence, already exists. It is nothing more and nothing less than a currency that is pegged to another or, to be precise, to 20 other currencies. The fact that we call it euro instead of drachma does not affect the substance. In essence, the euros that are credits on the central bank of Athens could be called drachmas.

 

Greece could leave the eurozone and the EU if it wished to

Of course, some will — and have already — say that leaving the euro without leaving the European Union is not possible and not legal. That is true but that to me reveals yet again another design flaw of the EU Treaties. Indeed, there was no provision to that affect. What the designers had in mind back then was probably that it would send a strong signal to investors, politicians and the public opinion, that the euro was strong and that it would never fall. Or, more like it, that if it did it would then take the whole building down, which was unthinkabe at the time.

So, if Greece wished to, it could just implement article 50 of the Treaty of the European Union and withdraw. The art 50 states that any country that wishes to can leave the union unilaterally. A period of two years starts at the notification of the member state to withdraw. If no agreements are reached after two years, the Treaty ceases to apply to this member state automatically.

It means that Greece could leave the union if it wished to, that it would then have two years to prepare the transition and that no other member state nor institution could ever prevent that from happening if Greece really wished to do so.

 

From the euro to the drachma

Legally speaking, going from the euro to the drachma is no more, no less complicated than it was to go from the drachma to the euro in 1999 (banknotes were introduced in 2001). It merely is a decision that has to be taken by the Parliament in Athens and is no more complicated than passing any other law in the Greek Parliament. Literally.

Technically speaking, given that the euros already exist in essence, the only three things that would change would be the name and graphics given to the drachma (provided they would call it drachma though no law forces them to). Usually there are contingency plans that have these type of details in store, no matter what Varoufakis may have said in previous interviews. But let say for the sake of arguments that they don’t have a graphic representation for the new drachma: they can always take a period of 6-8 months during which they would used stamped euros — it means euros that have a stamp on it and that turns temporarily euros into drachmas — while the Greek government decides on the technical details and the graphics.

The third and final change in comparison with the euro would of course be the exchange rate given to the new drachma. That would now be a sovereign decision that would need to be made by the central bank of Greece.

Of course, we could expect it to devalue its currency substantially. But that, would be the subject of another post…

8 Comments

  1. david marty July 30, 2015 2:37 pm 

    @marcos

    one last comment: once Greece would leave the eurozone, it would not need to resort to ECB nor IMF loans. it could simply ask its own Central Bank, the Bank of Greece.

  2. david marty July 30, 2015 2:34 pm 

    Marcos,

    Exiting the financial crisis and exiting the EU/eurozone are not two separate topics. They are very much related. Although the origins of the financial crisis were exterior to the EU, the kind of solutions that any economy would need to apply were rendered inaccesible by the euro, EU and its institutions.

    To give you one example. You mentioned capital flight as a problem. It definitely is. But unfortunately article 63 of the EU says the following: that “…all restrictions on the movement of capital between Member States and between Member States and third countries shall be prohibited.”.

    Capital flight can be prevented, but only for countries that are outside the European Unión.

    Also, if Greece exited the EU, it could then devaluate. It would then make their exports much more attractive. Inflation would not be a problem given the level of unemployment we see in Greece today. It means that at the same time that Greece’s monetary mass would increase its GDP would to.

    As for their debts, there would be plenty of options for Greece to repay their loans once they would be outside the euro. Default being one of them, although a partial cancelation of their debt would be more likely.

    The main problem for Greece would be that their debts are written in foreign law, which means that they would have to pay their debts in euro but with a depreciated drachma (in this likely scenario at least). There still would be plenty of options for the Greeks: debt haircut, tax incentives (to force creditors to accept payments in drachmas)…

    • marcos SM July 31, 2015 1:03 am 

      Thank you for taking time to answer, David.

      You mentioned that their exports would be much more attractive, but Greek industry is very weak, and their balance of trade is negative. It imports I think 50% of the food and 80% of medicines. And also there’s the debt repayment in devaluated drachmas. The devaluation would be a double edged sword to say the least.

      I doubt there would be any foreign inversion, and the incapability to repay the debt would make the IMF to impose sanctions. The greek central bank, as you said, could print money, but that would lead to further devaluation. In the best scenario, it would take years to build a significant industrial sector and revert the negative balance of trade.

      You were right about capital flights. And I don’t know enough about economics to be certain about how it would work the whole devaluation, inflation affair in a deflationary situation.

      Finally, I’m not saying Greece shouldn’t leave the EU, I just think it is a very difficult question.

  3. david marty July 30, 2015 2:21 pm 

    PS: it is however worth mentioning that Greeks would probably never call it “euros” if they were given the choice. In greek euro sounds too much like “uro” which means “pee”. In English it gave the Word “to urinate”. In fact Greeks much preferred the previous choice “ecu”, but the Germans at the time already were imposing their will over that of Greece and chose euro (for similar reasons).

  4. david marty July 30, 2015 2:18 pm 

    Hi Rob,

    In this post I only argued about the legal and technical aspects. And yes, it appears to be that simple. If you suspend the peg (by exiting the eurozone) you have your own currency. Then whether you want to call it drachma, new euros or any other thing is a symbolic question.

  5. marcos SM July 29, 2015 11:33 pm 

    The problem is not leaving the euro, or going back to the dracma. That’s the easy part the way I see it. The problem is that there is a financial crisis in Greece, it doesn’t have liquidity and it needs the loans of the ECB. Outside the euro, the ECB won’t provide any loans. Of course, with its own currency the country could print more money and devaluate, but that would be a problem in itself too. Also I would say there would be more capital flight.

  6. Steven Que July 29, 2015 4:20 am 

    Thanks, David. This article was quite enlightening.

  7. avatar
    Paulo Rodriguez July 28, 2015 8:45 pm 

    Intriguing article, David. Could it be really THAT “simple”?
    Any idea what Syriza’s leadership thinks about this?

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