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Dismantling the euro: a practical guide

A British economist produces a serious step-by-step manual for a nearly unthinkable option

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Europe is in undeniable trouble, with many of its economies now in recession, or slipping into one. And the euro itself—a currency that many believed would dethrone the dollar—has been making the problem much harder to solve. In the past, a struggling nation like Greece or Spain might escape a downturn by running deficits or devaluing its currency in order to make its exports cheaper. But the countries within the so-called eurozone are locked in a tight monetary embrace, obligated to keep a rein on their deficits and forced to do business in a currency their governments don’t control.

Nearly every month, Europeans leaders announce a new plan to save the eurozone from the troubles of its weaker members, a group known unflatteringly as the ­"PIIGS"—Portugal, Ireland, Italy, Greece, and Spain. Proponents of the eurozone haven't been at a loss for ideas as to the appropriate response: heavy helpings of austerity, bailouts, debt restructuring, and bond purchases by the European Central Bank. There's even talk of a fiscal union—tying the continent even closer together by bringing taxing and spending under one common government.

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Lost in all of this is another possible solution to the eurozone’s woes: dismantling the monetary union itself, or at least coming up with a way for its weakest members to exit gracefully. If Europe’s lagging economies can’t solve their problems without defaulting and bringing the rest of the continent down with them, letting the PIIGS go free could offer a way to save the euro.

But therein lies a problem. The architects of the eurozone were so optimistic about success that they never provided a road map for how, precisely, a nation might exit. Absent such guidance, any nation that withdraws from the eurozone may well trigger financial panic and political chaos. On a more practical level, a country like Greece doesn't have currency on hand to replace the euros already in circulation: The drachma was phased out in 2002.

It's a knotty problem. How can a nation like Greece exit the European Monetary Union without destroying either itself or the larger global economy? Answer that question, and it's possible to solve the eurozone crisis, but not, perhaps, the eurozone itself.

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Last November, someone did ask a version of that question, and in order to guarantee a response, offered a little enticement: £250,000—more than $400,000—for the best answer.

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The man behind the prize, Simon Wolfson, is a member of the British House of Lords (formally, he's known as Baron Wolfson of Aspley Guise). Wolfson, 44, is also the chief executive officer of the British clothing chain Next as well as a high-profile contributor to the Conservative Party. He is far from a disinterested observer: A well-known "euroskeptic" who believes a shared European currency simply can't, or shouldn't, survive, Wolfson justified the staggering size of the prize because it would "ensure that high quality economic thought is given to how the euro might be restructured" into what he pointedly described as "more stable currencies."

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Police in riot gear during demonstrations against wage cuts and austerity measures in Athens last month.
Police in riot gear during demonstrations against wage cuts and austerity measures in Athens last month.Kostas Tsironis/Bloomberg

Wolfson gathered a panel of judges from policy and government circles in Britain and the continent to evaluate the submissions. The chair of the prize committee, Derek Scott, former economics adviser to Tony Blair, had also been a longtime critic of the eurozone. Among the 420 individuals and firms that answered the call was Roger Bootle, an economist and managing director of Capital Economics, a research firm whose clients include hedge funds, property developers, and investment banks. His 156-page report, straightforwardly titled "Leaving the Euro: A Practical Guide," won the prize this past July.

Like many Britons, Bootle shares the skepticism of Wolfson and Scott, and his proposal carries nothing in the way of an official eurozone imprimatur. But its great detail and the publicity generated by the award means that policy thinkers now at least have a well-articulated Plan B to consider.

For anyone seeking an easy fix, Bootle's proposal is not reassuring. The plan looks a bit like a coup that plays out along monetary rather than military lines. He suggests that a successful breakup will need to be orchestrated by a small circle of a country's elite policy makers working very quickly—committing to this course no more than a month in advance, in order to avoid news of their plans leaking to the public. For good or for ill, such a decision would not be democratic: There would be no debate or public discussion. Secrecy is essential to the plan; indeed, Bootle refers to the day a nation exits the monetary union as "D-Day"—an interesting word choice, given its association with the last campaign to liberate Europe from German rule.

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Three days prior to D-Day, these officials would notify other partners in the eurozone. At the same time, they would shutter the country's domestic banks and suspend its financial markets to prevent people from yanking their money out as soon as the announcement came down. The plan is quite specific: All this would need to take place on a Friday, with a promise made that everything would reopen on Monday.

Over the weekend and on D-Day itself, all wages, prices, loans, deposits, and even the nation's sovereign debt would be redenominated in the new currency—the resuscitated peseta or drachma. Bootle's team counseled that the country exiting the eurozone avoid any attempt to guess the correct exchange rate, instead setting the new rate at 1:1. If a pensioner had 100,000 euros on the eve of D-Day, he would wake up the next morning to find that he now had 100,000 drachmas in his bank account instead, though these would almost instantaneously depreciate relative to the euro, leaving everyone with less purchasing power. The change from the euro to drachma would, in effect, function as a devaluation of the currency.

That's bad enough for the average Greek, but ordinary citizens would face a more pressing problem: the fact that banks wouldn't have drachmas printed and ready to hand out to depositors. Bootle's proposal spends a great deal of time on this problem, and with good reason: This issue is often raised as an insurmountable obstacle to any nation exiting the eurozone.

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Bootle's staff found that it takes approximately a half year to commission, design, and print new currency. That's a long time. If Greece tried this, news that it had commissioned bank note companies to print drachmas would inevitably leak out, sparking chaos and capital flight. Likewise, another obvious solution—putting a government stamp on existing euros and calling them drachmas—has its problems: As the drachma quickly lost value, it's likely that these drachmas-née-euros would disappear from Greece on the assumption that they could be accepted as euros elsewhere in Europe, especially if you could find a way to remove the stamp.

In the end, Bootle opted for a simpler, if messier, solution. "You need to make the initial break without notes or coins," he explains. This is feasible, he argues, because most commerce between companies, governments, and major players in the economy depends on electronic deposits, debit cards, and other surrogates for cash, which could, in theory, be readily switched to another currency. The need for physical cash, meanwhile, could be filled by the euros already in people's pockets, which would remain legal tender for small transactions. In effect, a country like Greece would temporarily rely on a dual currency system. Drachmas would be used in all noncash payments—credit cards, debit cards, and money orders. Euro notes and coins would be the money actually in circulation. Greeks would treat the euro as a foreign currency within their own borders, much the way that citizens of many developing nations use paper US dollars as a more stable alternative to their own domestic currencies.

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Changing currencies is one thing. But the PIIGS are also saddled with huge amounts of debt, in the form of euro-denominated bonds held by investors. Once they're out of the monetary union, they can default. Bootle's plan calls for a country like Greece to declare it is defaulting on much of its debt the same weekend it leaves the euro. "There isn't a cat in hell's chance that [bondholders] will get their money back," he says of Greece—though countries need not default on all of their debt, only enough to reduce the ratio of debt to gross domestic product to manageable levels. (Under current conditions, that means Greece's bondholders would take a 80 percent loss; Spain's creditors could get away with a 44 percent loss.)

Historically, default and currency devaluation can trigger banking crises, as banks see the value of their assets—government bonds—decline overnight. Bootle believes that any country exiting the eurozone will need to immediately reconstitute its own national central bank to act as a lender of last resort. The revived Bank of Greece would then begin creating drachmas out of thin air—with a few keystrokes of a computer—to provide liquidity where needed; it could then buy up bonds and other assets to keep markets from spinning out of control. If these measures prove insufficient, some banks may simply need to be nationalized until the economy recovers and the currency stabilizes.

None of this would be easy for ordinary citizens. While wealthier people with bank accounts in other countries would essentially enjoy a windfall, most would see the value of their savings drop precipitously as the currency lost value. Many of these changes would fall disproportionately on the poorer members of society, and Bootle's report encourages policy makers to contemplate taxes and other measures "in order to redistribute wealth."

Soon, though, many of the disadvantages of withdrawing from the euro could, in Bootle's estimation, be advantageous on the world stage. Though imports would become significantly more expensive, exports would now be much cheaper, and the country would regain its former competitiveness, not to mention its reputation as a cheap travel destination. Default and redenomination might also enable a country like Greece to regain access to the bond markets. "History suggests that investment bankers will be knocking on [Greece's] doors very quickly," says Bootle, attracted by a country that is actually more likely to pay off its loans now than it was when it groaned under unsustainable levels of euro-denominated debt. Still, attracting new creditors would require credible commitments to reining in inflation, something that Bootle believes could be accomplished by having Greece issue inflation-indexed bonds, as well as instituting other measures aimed at price stability.

All this sounds well and good, but would it work? Barry Eichengreen, an economist at Berkeley who has written extensively about the challenges facing the eurozone, is highly doubtful. "It's beautifully crafted," he says of Bootle's plan, "but Ray Bradbury novels are beautifully crafted. But that doesn't make them realistic."

To Eichengreen, even a report as detailed as Bootle's underestimates the complexity of the problems a country would face pulling out of the euro; for instance, it would probably take legions of computer programmers weeks or months—not a frantic weekend—to insure that all the euros in the financial system had been genuinely converted to drachmas. He sees the report as less a serious plan than a piece of advocacy for dismantling the euro, which he anticipates would be catastrophic no matter how it was planned. Any exit would likely send the rest of the eurozone spiralling into the abyss, as uncertainty spread about who would fall next. "It would," he warns, "be Lehman Brothers squared."

To say that risk and messiness doom his plan, Bootle argues, misses a more important point. "People say that [a country exiting the eurozone] is going to be awfully messy and awkward," he observes. "But do you have a counterfactual that isn't messy and awkward? Have you been to Athens recently?"


Stephen Mihm is an associate professor of history at the University of Georgia, and co-author, with Nouriel Roubini, of "Crisis Economics: A Crash Course in the Future of Finance" (2010).