i

Tle NLWNLY approacl

lo unscrambIing lle Luro




Callerine Dobbs

5 }une 2012






ii

Contents
1. The threat to the global economy ..................................................................................... 7
Very different economies in the eurozone 7
This time might be different: a bigger shock than Lehman 13
The need for a Plan B 17
Yolk and White countries 18
Possible endgames for the eurozone 18
2. Achieving an orderly exit through the NEWNEY approach............................................. 25
Assessing different approaches to the exit of one or more states from the Euro 25
The impracticalities of a surprise redenomination 28
The NEWNEY approach in concept 31
Key steps in the NEWNEY process 36
3. Specific details on the NEWNEY approach.................................................................... 39
Setting the exchange ratio 40
Allowing FX movements and getting the exchange to happen in practice 45
Different monetary policies 49
Implications for private savings, domestic mortgages and international contracts 51
Implications for government debt 52
The stability of the banking system 54
The NEWNEY with more than 2 regions 55
Applying NEWNEY with a phased exit or with a small initial exit 55
4. Winnings and losers, and the politics. ............................................................................... 58
Evaluating winners and losers 58
The politics 61
Conclusions ........................................................................................................................... 65
Biography, contact details and acknowledgements .............................................................. 67

1

UnscrambIing lle Luro

Tle banIruplcy of Ielman Brollers provides a perlinenl Iesson for
lle eurozone. Irior lo lle Ielman coIIapse, llere vere cIearIy
subslanliaI underIying probIems vill gIobaI debl IeveIs in generaI,
and vill lle subprime morlgage and lousing marIel in parlicuIar.
Tlese probIems vouId lave been painfuI lo vorI llrougl in an
orderIy vay, bul lle disorder in lle financiaI marIels llal foIIoved
lle coIIapse of Ielman, resuIled in a seizing up of credil marIels,
and subslanliaIIy grealer impacl on lle gIobaI economy.
Il is evidenl llal some of lle probIems around Ielman's coIIapse
resuIled from reguIalors and poIicymaIers laving lad no
conlingency pIan in pIace for lov lo deaI vill a silualion sucl as
Ielman, and lov lo prevenl lle domino effecl as lle Ioss of
confidence slifled from Ielman lo oller financiaI inslilulions
around lle vorId. Tlese oller financiaI inslilulions, in lurn, llen
faced a coIIapse in Iiquidily and so villdrev credil from lleir reaI
economy cuslomers. Tle reduclion in Iending and credil, especiaIIy
in areas sucl as lrade finance, sIoved lle reaI economy. Tlis
domino effecl magnified lle impacl of lle coIIapse of Ielman,
resuIling in a gIobaI credil conlraclion and Ioss of confidence, vlicl
in lurn caused lle firsl gIobaI recession since lle Second WorId War.
One or more member slales Ieaving lle eurozone, if llis vere lo
lappen in a disorderIy vay couId, as viII be slovn, be a five lo len
limes Iarger evenl for lle gIobaI economy compared vill lle
Ielman coIIapse
1
. Tlere is an anaIogous domino effecl lo llal seen
vill Ielman, vill lle exil from lle eurozone of even one counlry. If
one counlry Ieaves lle eurozone, il viII be cIear llal memberslip of
lle eurozone is nol forever. And so financiaI marIels, specuIalors,
corporalions, and even cilizens couId slarl anlicipaling vlicl
counlry couId Ieave nexl. Tley vouId move deposils and assels oul
of financiaI inslilulions in vlal lley perceive lo be lle counlries llal
migll exil nexl, resuIling in a calaslroplic Ioss of Iiquidily and credil
in llese domino counlries. Tlis Ioss of Iiquidily and credil couId,

1
This paper in no way forecasts that any country will, or should leave the eurozone. It was written to
contribute one idea to a debate on possible options should a country decide to leave.

2

in ilseIf, precipilale lle need for some of llese domino counlries lo

exil lle eurozone as lle LCB and oller governmenl meclanisms
migll be unabIe lo provide sufficienl Iiquidily llrougl various
firevaII meclanisms lo offsel llese specuIalive fIovs and even if
lley are abIe lo provide sufficienl Iiquidily, lley migll be unviIIing
poIilicaIIy lo laIe lle risI of Ioss of some of lleir commilmenl lo lle
firevaII, if a counlry vere lo exil evenluaIIy. Tle UK's exil from lle
LRM is a perlinenl Iesson in llis regard: lle BanI of LngIand's
firevaII vas insufficienl lo offsel lle specuIalive fIovs vlicl
evenluaIIy drove lle Iound oul of lle LRM, crealing as Ioss for lle
BanI of LngIand on lle capilaI depIoyed in ils firevaII. Al a
minimum, llese domino counlries migll need lo inlroduce capilaI
conlroIs, vlicl combined vill lle Ioss of credil, couId resuIl in a
subslanliaI reduclion in economic grovll for aII lle members of lle
eurozone, and lle gIobaI economy.
Wleller lle eurozone viII or slouId remain logeller is beyond lle
scope of llis paper. Indeed, il is lard lo forecasl, as il is may be more
a queslion of poIilics llan a queslion of economics. Tlere are very
slrong economic and poIilicaI forces puIIing lle Union aparl and
very slrong economic benefils and poIilicaI viII Ieeping lle Union
logeller. Counlries in lle Union sucl as Greece need lo reslore lleir
compeliliveness, and a devaIualion foIIoving an exil from lle
eurozone vouId be lle naluraI vay of providing lle leadroom for
lle slrucluraI clanges in lleir Iabour marIels needed lo reslore lleir
compeliliveness in lle Iong run. Across lle eurozone, llere are
poIilicaI parlies sucl as Syriza in Greece llal viII maIe llis exil a
core parl of lleir economic eIeclion poIicy. Bul aIso core eurozone
counlries, sucl as Germany or lle NellerIands, migll become veary
of maIing ongoing lransfer paymenls lo oller counlries in lle Union,
and lle enduring moraI lazard of repealed faiIures lo meel auslerily
largels. AII counlries migll grov concerned on lle Ioss of sovereign
aullorily invoIved in a move lo a grealer fiscaI union.
Hovever, lle eurozone las aIso deIivered subslanliaI benefils
incIuding lle reduclion in lransaclion cosls and uncerlainly llal
comes from currency voIaliIily, and from Iover inleresl rales. And
some counlries, sucl as Germany llal in lle earIy years of lle
eurozone looI major sleps lo improve lleir produclivily and

3

compeliliveness, lave subsequenlIy benefiled from a Iover exclange

rale llan lley vouId lave lad villoul lleir memberslip of lle
eurozone: a fIigll lo a safe laven DeulsclmarI, and lle
consequenliaI apprecialion of llal currency, vouId lave undone
some or aII of lle improvemenls in produclivily and compeliliveness
llougl of course llis apprecialion vouId lave made foreign goods
cleaper for German consumers, and German consumers ricler.
In addilion, lle exil of severaI counlries from lle Luro couId aIso
compIeleIy devaslale lle banIing syslem of lle core counlries, as a
subslanliaI parl of lle banIing assels are leId in lle exiling counlies
and so vouId gel devaIued, vliIe lle banIs' IiabiIilies (mainIy
deposils) viII remain in lle Luro.
Hovever, lle eurozone's poIicymaIers face a diIemma. WliIe an exil
of one or more counlries from lle eurozone is by no means cerlain,
poIicymaIers need lo deveIop a IIan B for lov one or more
counlries couId Ieave lle eurozone so as lo minimise lle slocI lo lle
members of lle eurozone and lo lle vloIe gIobaI economy. Tlese
are sucl unclarled valers, llal lley need lo lave a vide debale on
oplions. Bul if lley vere lo iniliale a discussion of exil meclanisms,
lley run lle risI of increasing lle IiIeIilood of exil by encouraging
even more specuIalive fIovs. Tle debale on oplions by lle WoIfson
Lconomic Irize is llerefore lo be veIcomed. Lven if lle rigll ansver
is lo Ieep lle Luro logeller, a debale on lle eIemenls of a IIan B is
needed. IoIicymaIers cannol run lle risI llal comes from lle IacI of
preparalion llal occurred before lle Ielman coIIapse.
And indeed, lle deveIopmenl of a pIan B couId aIso, paradoxicaIIy,
supporl lle Luro Zone remaining inlacl for lvo reasons. Iirsl, il
couId increase lle pressure on aII counlries llal benefil from lle
eurozone lo vorI on lleir pIans for Ieeping lle eurozone logeller.
SecondIy, if lle pIan is sucl llal llere is no incenlive for capilaI lo
fIov oul of counlries llal migll exil, lle risI of deslabiIising capilaI
fIovs slouId be reduced. And as las been discussed, llese
deslabiIising capilaI fIovs llemseIves couId resuIl in a counlry being
forced lo exil lle Luro, or bring aboul oller fundamenlaI clanges in
lle eurozone sucl as lle removaI of lle free fIov of capilaI.

4

A badIy managed process by vlicl one or more counlry Ieaves lle

Lconomic Monelary Union is, llerefore, in ilseIf probabIy lle biggesl
llreal lo lle fulure grovll and prosperily of lle currenl
memberslip of lle eurozone. To conlribule lo lle debale on a vider
sel of oplions, llis paper comes al lle probIem from lle perspeclive
of an inveslor, and presenls a very non-lradilionaI vay for lov lle
economic processes couId be managed lo aIIov lle orderIy exil of
one of more member slales from lle eurozone. Tlis suggesled
approacl borrovs from llal used by corporales vill equily spin-
ouls. Il llerefore removes mucl of lle incenlives for deslabiIising
capilaI fIovs llougl some migll sliII occur because of lle risI of
banIing faiIures - so in facl couId aIso supporl lle eurozone
remaining logeller.
Ior reasons llal viII become apparenl, llis pIan is caIIed
NLWNLY. Al lle learl of llis pIan is lle NLWNLY IrincipIe,
nameIy llal aII Luros, vlerever lley are in lle Union, gel lrealed
equaIIy. And lle exil of one or more counlries is nol vieved as an
exil, bul a spIil of lle Union inlo a core region and a sel of separaling
counlies (or counlry). Tlis paper buiIds on lle unscrambIing
anaIogy
2
lo caII llese lle Wlile region and YoII counlries, vlere il
is lle YoII counlries llal need lo reslore compeliliveness llrougl
devaIualion, and lle Wlile llal are lle core counlries lo lle Luro
3
.
Tle YoII couId cIearIy be a singIe counlry sucl as Greece or a sel of
counlries sucl as Greece, IorlugaI, IreIand, and Spain.
Lacl of lle Wlile region and YoII counlries vouId lave lleir ovn
cenlraI banIs, monelary poIicies and currencies in llis paper llese
currencies are caIIed lle Nev Luro-Wlile (NLW) and lle Nev Luro-
YoIIs (NLYs). Tle YoII counlries vouId be abIe lo pursue a
devaIualion of lleir currency over lime. Tlis couId be aclieved

2
Many have used the omelette analogy. For instance, Wolfsons prize is impossible to win by Tim
Harford, Undercover Economist October 21, 2011 Financial Times
3
If you approach this as a fried egg analogy, you end up thinking of the core countries as the Yolk and
the periphery countries as the White. However, as Tim Hartford (ibid) has pointed out, the Euro is more
of an omelet than a fried egg. Its the sunny yolk countries that have too much cholesterol (debt) but
maybe for some are a bit more yummy. The White countries are snowy, and some believe that we need
to move to more of a lower cholesterol egg white omelet. For a detailed nutritionist discussion, see
Hugo Dixons Reuters BreakingViews:
http://www.reuters.com/video/2012/04/16/reuters-tv-breakingviews-can-the-euro-omelette-be-
u?videoId=233383502&videoChannel=117766

5

graduaIIy villoul a run on lleir currency llrougl ligler inleresl

rales and ligler infIalion.
Tle lransfer lo lle nev currencies, and equaI lrealmenl of aII Luros
llrougloul lle eurozone, can be aclieved by lle cenlraI banIs
agreeing llal every exisling Luro gels exclanged for a fixed
combinalion of lle lvo currencies, lle Nev Luro-Wlile (NLW) and
lle Nev Luro-YoII (NLYs). As an exampIe for a singIe counlry
exiling, a Luro couId gel exclanged for 0.8 NLWs and 0.2 NLYs
lov llis exclange ralio couId be sel is discussed Ialer. As NLWs and
NLYs become lle IegaI lender, il vouId sliII be possibIe lo delermine
lle vaIue of lle oId Luro denominaled in NLWs or in NLYs from
lleir reIalive exclange rale and lle exclange ralio llal vas fixed al
lle slarl. Tlis approacl, llerefore, aIIovs for lle aulomalic
redenominalion of currenlIy Luro-denominaled assels, conlracls and
IiabiIilies. Tle equaI lrealmenl of aII Luros removes lle incenlive for
mucl of lle specuIalive capilaI fIovs llal couId easiIy deslabiIise lle
eurozone llougl some couId be lriggered by lle risI of counlry
defauIl. Tlis fuII NLWNLY approacl is designed for lle exil of a
number of counlries. Tlis paper aIso suggesls a NLWNLY-Iile
approacl llal can be used for lle exil of a smaII counlry sucl as
Greece.
Tlis enlry for lle WoIfson Irize focuses on defining and delaiIing
lle execulion of llis NLWNLY approacl.
4
Tle enlry las been
submilled vill lle inlenlion of conlribuling lo lle debale for oplions
around a IIan B llal vouId aIIov one or more counlries lo Ieave
lle eurozone in an orderIy vay, and so as lo prevenl Ielman lype
slocIs lo lle gIobaI credil syslem. Il is imporlanl lo slress llal il
does nol suggesl llal lle breaI-up of lle eurozone is in any vay
desirabIe or inevilabIe. Indeed llal is a decision for lle peopIe and
poIilicians of lle eurozone, and, as Vince CabIe las poinled oul, il is
nol inappropriale for someone from Brilain lo be seen Iecluring lle
counlries of lle eurozone on lov lo run lleir economies. Hovever,
a IIan B is needed so llal if a lransilion becomes required, il can

4
A number of others have described approaches with some similarities to NEWNEY. These include: I'm
claiming the 250,000 Wolfson prize for how to break-up the Euro by Jeremy Warner, Daily Telegraph 6
January 2012. Why we must break up a failing Euro by Martin Jacomb, Financial Times May 23 2012.
Olaf L. Mueller: "Eine Zentrifuge fuer den Euro". Neue Zuercher Zeitung NZZ No. 37 (February 14th,
2012), p. 19.

6

be managed so as lo provide a minimum impacl on Luropean and

gIobaI grovll and veIfare.
Tle NLWNLY approacl in llis paper provides some componenls
llal couId be incIuded in llis pIan, as a conlribulion lo lle debale.
Bul lle NLWNLY approacl couId aIso supporl lle eurozone
remaining logeller as il reduces lle risI of specuIalive capilaI fIovs
llal couId deslabiIize lle Union. So paradoxicaIIy, a pIan llal vouId
aIIov a member slale lo Ieave lle eurozone, couId aIIov lle Union
lo remain logeller. Tle reaI pover of NLWNLY migll come from il
never being used.


7

1. Tle llreal lo lle gIobaI economy

Tlere are subslanliaI lensions inlerenl in lle eurozone llal raise
serious doubls on vleller lle Union can remain logeller in ils
currenl form. CapilaI oulfIovs from some of lle soullern counlries
are al lle momenl conlainabIe, bul llese fIovs couId become a fIood
llal couId in lle end force a counlry or counlries lo Ieave lle union.
Hovever, a precipilous exil of one of more pIayers from lle Union
couId resuIl in a major slocI lo lle gIobaI economy, a slocI llal is
orders of magnilude Iarger llan lle coIIapse of Ielman Brollers.
Tlerefore, poIicymaIers need lo deveIop a pIan for lov an exil
couId be managed in an orderIy vay and lov lle capilaI oulfIovs
can be managed.
Tlis clapler expIores lle lensions inlerenl in lle eurozone, lle risIs
of a disorderIy exil, and expIains vly a IIan B llal couId aIIov an
exil of one or more counlries is needed. Il aIso Iays oul some possibIe
endgames for lle Union, vlicl vliIe lley are oulside lle direcl
scope of lle WoIfson Lconomics Irize queslion, are a necessary
ingredienl lo soIving lle poIilicaI aspecls of lle process of separalion
vlicl are in lle scope of lle prize.
Very different economies in the eurozone
Tlere vere cIearIy subslanliaI differences belveen lle economies
and monelary poIicies of lle Luro counlries before lle crealion of lle
eurozone. IrobabIy lle mosl subslanliaI difference vas around
differences in educalionaI IeveIs and demograplics, bul aIso lleir
approacl lo produclivily, currency deprecialion and infIalion. As
can be seen from Clarl 1, Germany lisloricaIIy relained
compeliliveness despile a slrong currency llrougl produclivily
grovll and Iov vage infIalion. Al lle oller end of lle speclrum,
Greece, prior lo lleir enlry inlo lle Luro, lad ligler vage infIalion
bul remained reIaliveIy compelilive llrougl a Iong run deprecialion
of lle draclma. Oller counlries sucl as IlaIy and Spain lad ligler
currency deprecialion llan Germany and llis aIso aIIoved ligler
vage infIalion, villoul Ioss of compeliliveness.

8

Tle crealion of lle eurozone on lle 31 December 1998,

5
clanged llis
silualion. Tle Luro no Ionger deprecialed al lle lisloric rale seen by
lle Draclma, Iira, Iesela, or lle Lscudo. Hovever vage infIalion in
many of llese counlries remained more in Iine vill lle lisloric rales
llal vorIers, managers and lle governmenl lad grovn up vill.
WliIe Germany vas underlaIing lle difficuIl sleps (Gerlard
Sclrder puls lis 2005 eIeclion Ioss dovn lo lle unpopuIarily of
llese measures) lo increase lleir produclivily and compeliliveness in
lle earIier years of lle Luro, many oller counlries did nol. Irom
2000 lo 2010 German unil Iabour cosls onIy increased around 2
vliIe llose in Greece, IlaIy and Spain increased by nearIy 30.
6

CHART 1
Sources: Oanda; OECD
Currency devaluaLlon versus 5, 1990 - 1998,
0
3
10
13
20
23
30
33
40
43
30
-

Will lle benefil of lindsigll, il is cIear llal lle inlroduclion of lle
eurozone vas nol accompanied by lle required clanges in allilude
and mindsel on infIalion, produclivily and vages across aII of lle
eurozone, and lle inlroduclion of lle required programmes lo
improve produclivily and compeliliveness. Iabour mobiIily is sliII
Iimiled. Ten years Ialer lle compeliliveness of lle soullern counlries

5
While the Euro notes and coins were not introduced until January 2002, two years later, the exchange
rates between countries were locked on the 31 December 1998.
6
Wage data from OECD dataset.

9

in lle eurozone, in parlicuIar, las subslanliaIIy delerioraled. Tleir

governmenls lave been abIe lo laIe up some of lle sIacI (or avoid
lle immediale need for slrucluraI clange and produclivily
improvemenls) by borroving more, laIing advanlage of lle Iover
inleresl rales and easy credil llal lave come from lleir memberslip
of lle Luro. Tle grovll in governmenl debl for llese counlries is
iIIuslraled in Clarl 2. Hovever, il isn'l jusl governmenls llal
borroved. HouseloId debl las aIso risen. Ior exampIe, in 2000
GreeI louseloId debl vas around 10 of GDI, bul by 2010 llis lad
risen lo 60. IorlugaI's louseloId debl in lle same period rose from
around 55 of GDI lo around 95.
7

CHART 2
Sources: ECB Statistics Pocket Book
Change ln governmenL debL from 1999 and 2010, of Cu
61
39
63
34
49
113
103
83
82
61
93
93
118
143

WliIe llis sudden grovll in debl masIed underIying produclivily
issues for a vliIe, il is cIear llal soullern Luropean economies are
nov suffering from a Ioss of compeliliveness, increased governmenl
deficils and ligl unempIoymenl. In Greece and Spain, for inslance,
unempIoymenl is running al around 19 and 23 respecliveIy
compared lo around 10 for lle LU as a vloIe.
8
Tle financiaI

7
Debt data from The McKinsey Global Institute Debt and Deleveraging reports
8
Source: European Central Bank, Statistic Pocket Book, January 2012.

10

marIels and credil raling agencies lave Iosl confidence in some

governmenls' abiIily lo repay debl, maIing lle cosl of raising nev
debl very ligl and even mainlaining exisling debl IeveIs very
expensive. And some governmenls lave become reIianl on lransfer
paymenls and guaranlees from lle norllern counlries, as veII as lle
Luropean CenlraI BanI buying lleir sovereign debl and funding
lleir foreign exclange reserves, oflen indireclIy llrougl lle banIing
syslem and lle Targel 2 inlerbanI paymenl syslem.
Tle experience of deveIoping counlries las slovn llal devaIualion
is nol, in ilseIf, a grovll slralegy. Il purclases compeliliveness by
maIing lle counlry poorer and so in lle Iong run is nol a subslilule
for produclivily grovll as a source of compeliliveness. Bul il can
leIp in some silualions lo reslore compeliveness. Il is cIear llal a
number of lle eurozone soullern counlries couId benefil from lle
improved compeliliveness llal couId come from a devaIualion of
lleir currencies, if lley vere lo Ieave lle eurozone. A devaIualion
via an exil vouId aIIov compeliliveness lo be reslored more quicIIy
llan llrougl an combinalion of inlernaI devaIualion and auslerily
programmes, and so couId leIp reslore grovll and reduce
unempIoymenl. Bul llis onIy vorIs if vage infIalion does nol erode
any benefils in lerms of exlernaI compeliliveness. An exil ccu|! aIso
leIp address governmenl deficils and debl IeveIs because grovll
vouId be reslored llougl lleir deficil and indebledness vouId
aIso be dependenl on lle lrealmenl of lleir sovereign debl in lle
reslrucluring around lleir exil, and lleir evenluaI credilvorlliness.
Conlrary lo popuIar beIief, il vouId nol aIIov debl IeveIs lo be
reduced by prinling money as in lle Iong lerm llis viII resuIl in
ligler inleresl cosls.
9

WliIe llere are benefils from some counlries exiling lle Union and
devaIuing lleir currency, llere are aIso conlinued subslanliaI
benefils lo be gained from lle eurozone remaining logeller.
Transaclion cosls and uncerlainly llal comes from currency
voIaliIily is reduced subslanliaIIy. Various eslimales pul lle increase
in lrade llal resuIled from lle Luro al around Luro 100 lo Luro 300

9
See The euro: love it of leave it? By Barry Eichengreen, VOX 4 May 2010.

11

biIIion per annum

10
. CapilaI las fIoved mucl more belveen Luro
counlries llan prior lo lle Union as a resuIl of lle near removaI of
exclange rale risIs villin lle eurozone. Tlis capilaI fIov las leIped
conlribule lo Iover inleresl rales, on average, across lle eurozone.
And in recenl years, some counlries sucl as Germany lave benefiled
from lle compeliliveness llal came from a Iover exclange rale llan
lley vouId lave lad villoul lle eurozone. As lle Boslon
ConsuIling Group poinls oul: Germany, vlere unempIoymenl las
faIIen sleadiIy despile lle recession and debl crisis, presenls a
reIaliveIy posilive piclure villin Lurope. By loIding vages sleady,
raller llan raising llem, lle counlry las improved ils
compeliliveness villoul increasing unempIoymenl.
11

Bul il seems cerlain llal in a non eurozone vorId, lle DeulsclmarI
vouId lave slrengllened considerabIy, given lle produclivily
improvemenls aclieved in earIier years on lle Luro. In llis, il is
perlinenl lo IooI al lle performance of llose oller currencies llal
are vieved as safe lavens. Irom Augusl 2008 lo lle end of 2011, lle
Sviss Iranc oulperformed lle Luro by 32, llougl lle Sviss Iranc
las subsequenlIy veaIened as a resuIl of lle recenl governmenl
announcemenls and inlervenlion. Tle }apanese Yen, anoller
perceived safe laven currency slrengllened by 54 in llis period
againsl lle Luro, despile considerabIe domeslic probIems incIuding
a debl lo GDI ralio of 220 and a decIining popuIalion. GoId las
aIso slrengllened by 125 vlen vaIued in Luros. If lle
DeulsclemarI lad sliII been in exislence, il is IiIeIy lo lave
subslanliaIIy apprecialed, lurling lle compeliliveness of German
exporlers. German exporls vouId IiIeIy lave been reduced by
lundreds of biIIions of Luros
12
if lley lad relained lle DeulsclmarI
currency and llis currency lad apprecialed in llis vay, llougl
cIearIy lle veaIll of Germany vouId lave aIso benefiled from a
slronger currency.

10
See The Euro's Trade Effects, Richard E. Baldwin (2006)
11
Tracking Consumers Through Europes Debt Crisis by Ivan Bascle, Camille Egloff, and Catherine
Roche, BCG May 17, 2012
12
Authors estimate.

12

Tle benefils from loIding lle eurozone logeller migll veII be

sufficienl lo compensale for lle cosls and IacI of compeliliveness of
some of lle members. Indeed, lle compeliliveness of lle soullern
counlries couId be reslored llougl auslerily, saIary culs, oller
inlernaI devaIualion, produclivily programmes and polenliaIIy a
more Luro infIalion, especiaIIy in lle core counlries. Germany's
experience in lle earIier years of lle Luro las slovn llal il is
possibIe lo aclieve llis produclivily improvemenl llougl slrucluraI
clange, llougl lley did lave a mucl leaIllier gIobaI economic
environmenl vlen lley did llis. Tle ongoing lransfer paymenls,
IargeIy from Germany lo lle soullern counlries couId be vieved as
good vaIue for lle compeliliveness lle eurozone brings German
exporlers from a veaIer exclange rale, as veII as lle benefils from a
reduclion in voIaliIily and lle associaled lransaclion cosls, even if
lley perpeluale a defeclive grovll modeI and clange lle incenlives
for lle counlries receiving lle paymenls.
In addilion, any separalion is bound lo be expensive and a major
dislraclion. TaII of il is aIready causing massive marIel voIaliIily
and reducing inveslmenl. Tle vaIue llal comes from lle avoidance
of lle pain and cosl of separalion is significanl.
Bul lle lensions of lle Ioss of compeliliveness of lle soullern
member slales and lle poIilicaI cosl of llese lransfer paymenls viII
be subslanliaI Counlries sucl as Greece lle over 40 gap in
compeliliveness measures sucl as GDI per lour vorIed compared
lo Germany vouId be a Iong and painfuI process lo cIose fuIIy. Tle
German experience aIso sloved llal slrucluraI clanges can be
delrimenlaI poIilicaIIy, vill lle German ClanceIIor Gerlard
Sclrder nov saying llal le beIieves le Iosl lis job because of lle
programmes.
13
.
Hov llis pIays oul viII be more of a poIilicaI process llan an
economic process. As a resuIl il is lard lo forecasl. WiII lle volers of
aII lle soullern counlries accepl lle pall of auslerily, vage
reduclions and unempIoymenl or couId popuIisl candidales gel
eIecled in one of more counlry on a pIalform of an exil from lle Luro,
a devaIualion, and maybe a defauIl on some sovereign debl` WiII lle

13
Interview with Robert Peston on The Great Euro Crash. BBC

13

volers in lle norllern counlries accepl lle ongoing need lo subsidise

counlries in lle soull` And be prepared lo accepl llem missing lleir
largels` WiII lle Ieaders of lle core counlries, be prepared lo
abandon lle poIilicaI capilaI lley lave aIready spenl as veII lle
capilaI lied up in lle various firevaIIs. WiII lle volers of lle
eurozone undersland lle pros and cons of differenl oplions` Hov
viII lle reIalionslip belveen lle Ieaders of lle differenl counlries
evoIve in lerms of vorIing logeller` Hov viII aII of llese issues
pIay oul in lle coaIilion governmenls llal exisl in a number of
counlries`
CHART 3
Note: The Intrade volumes are relatively thin in this market.
SOURCE: www.intrade.com
30
33
40
43
30
33
60
63
70
73

Given aII of llis, llere is a subslanliaI risI llal one or more counlry
couId decide lo exil lle eurozone. And indeed, lle prediclion marIel,
Inlrade nov puls al around 65 lle probabiIily llal one or more
counlry viII announce ils inlenlion of Ieaving before lle end of 2014
see clarl 3.
This time might be different: a bigger shock than Lehman
Tlere lave been many exampIes of oller counlries Ieaving monelary
unions or lle breaI up of lle oller currency unions. Indeed a

14

number of lle oller enlranls lo lle WoIfson Lconomics Irize lave

done a plenomenaI job al documenling llese.
14

Hovever, lle claIIenges of lle eurozone are of a differenl
proporlionaI order of magnilude llan llese lisloric exampIes
because of lle reIalive scaIe of lle eurozone and exlenl of lle
inlerconneclion vill lle gIobaI economy. Iels IooI al some bacI of
lle enveIope numbers lo gel some sense of lle scaIe.
In 1992, CzeclosIovaIia represenled around 0.4 of gIobaI GDI. In
1913 (i.e., before lle deslruclion of lle Iirsl WorId War), lle Auslro-
Hungarian Lmpire vas around 5 of gIobaI GDI llougl cIearIy
by lle lime lle currency union vas dissoIved lle Iirsl WorId War
lad bougll a degree of addilionaI claos lo lleir economy. WliIe
Greece loday al around 0.4 of gIobaI GDI couId be considered
anaIogous lo CzeclosIovaIia, lle eurozone as a vloIe nov
represenls over 20 of gIobaI GDI, so 4 limes lle var slallered
Auslro-Hungarian Lmpire and 50 limes lle VeIvel RevoIulion of lle
CzeclosIovaIia breaI up.
15

In addilion, lle gIobaI economy las become mucl more IinIed.
Angus Maddison's researcl slovs llal for lle Iasl lvo cenluries,
gIobaI lrade voIumes lave grovn rouglIy 1.7 fasler llan grovll in
gIobaI GDI.
16
Tlis vouId suggesl llal lle gIobaI lrade lo GDI ralio
viII lave risen by around a faclor of 4 since lle Auslro-Hungarian
Lmpire dissoIulion.
And a simiIar increased IinIage comes from cross border capilaI
fIovs. In 1980 (vlicl is lle firsl year ve can gel dala), cross border
capilaI fIovs vere around 4 of gIobaI GDI. By 2005 llese lad
reacled 15. SimiIarIy lle slocI of foreign inveslmenl assels (i.e.,
assels leId cross border) las grovn considerabIy. In 1990, foreign
inveslmenl assels vere around $10 lriIIion or around 55 of gIobaI
GDI. By 2010, llis lad increased by nearIy a faclor of len lo $96

14
For instance see A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solution
by Jonathan Tepper, Wolfson Economics Prize entry, April 2012. Available from policyexchange.org.uk
15
The calculations are very approximate and draw data from Paul Bairochs Europe's Gross National
Product: 18001975; the IMF; and Angus Maddisons Contours of the World Economy, 12030 AD.
Essays in Macro-Economic History; and the IMFs Report for Selected Countries and Subjects.
16
We have been unable to find country specific numbers so are using global numbers as an estimate.
Numbers are from Angus Maddsions Growth and Interaction in the World Economy.

15

lriIIion, or 160 of gIobaI GDI.

17
So in 20 years, lle foreign
inveslmenl assels lo GDI rose by a faclor of 3. If llis rale of clange
lad been mainlained (and llis is a big if), over 90 years llis vouId
lave increase by over 100.
So lle eurozone is al Ieasl 4-50 limes Iarger and couId be 4-100 limes
more IinIed, boll as a proporlion of gIobaI GDI, lo lle resl of lle
gIobaI economy llan oller currency unions llal lave been dissoIved.
Il is llerefore cIear llal one or more member slales Ieaving lle
Luropean Monelary Union in a disorderIy vay ccu|! be an orders of
magnilude Iarger slocI for lle gIobaI economy llan lle exil from
previous monelary unions.
CHART 4
0 300 1,000 1,300 2,000 2,300 3,000 3,300 4,000 4,300 3,000 3,300
Sources: Data from McKinsey Global Institute; national sources; Lehman Brothers 10Q filings May 2008; author analysis
1 The comparison is made to illustrate the scale of the shock but is not an exact like for like comparison. Not all of Lehmans assets were exposed to
bankruptcy because of netting, and not all of the countries cross border debt will be exposed to redenomination as there might be matching assets. The
analysis assumes approximately 30% of total debt as of Q2 2011 is held cross-border for Greece, Ireland, Italy, Portugal and Spain and that 90 days of
annual export and import contracts are at risk before contracts are renegotiated. The 30% cross border assumption is based on EBAs estimate that
around 30% of Greek sovereign debt and interbank lending is held by overseas banks, and around 40% of sovereign debt for Ireland and Portugal.
Detailed cross-border debt data is generally not available. These are the authors assumptions for this comparison. You can make your own but the
message remains similar with most assumptions.
2 As of May 2008, Lehman Brothers had $639.4 billion of assets, $613.2 billion of liabilities and $26.3 billion of equity.
'
8x

Indeed, an exil couId aIso be an order of magnilude slocI lo lle
gIobaI economy compared vill lle Ielman coIIapse. WliIe lle
comparison is nol exacl, lle oulslanding conlracls Ielman lad al
lle poinl of coIIapse can be compared lo a rougl eslimale of lle size
of cross border sovereign, financiaI inslilulions, corporale and
louseloId debl, as veII as llree monll of imporls and exporl
conlracls. Tlis debl and llese imporl and exporl conlracls vouId be

17
Data from McKinsey Global Institute, Mapping the Global Capital Markets 2011.

16

exposed lo clanges in vaIue, and uncerlainly on lleir vaIue, as one

or more member slale Ieaves lle Luropean Monelary Union, and
lleir unil of exclange gels renegolialed. Tlis is anaIogous lo lle
Ielman conlracls llal vere exposed lo clanges in vaIue, and lle
corresponding uncerlainIy because of lle Ielman banIruplcy.
Clarl 4 compares, as an iIIuslralion, lle vaIue of oulslanding debl
and an eslimale of vlal migll be lle exisling imporl and exporl
conlracls llal are exposed lo clanges in vaIue lle foolnole expIains
lle basis for lle comparison.
Tlis rougl eslimale suggesls llal even a smaII economy in lle
eurozone sucl as Greece las exisling debl, and imporl and exporl
conlracls llal couId be around laIf lle size of Ielman's conlracls.
Ior IlaIy, llis number vouId be 3 lo 4 limes lle size of Ielman's
conlracls. If IorlugaI, IreIand, IlaIy and Spain are aIso incIuded, lleir
cross border debl and imporl and exporl conlracls couId be as mucl
as 7 lo 8 limes lle Ielman conlracls.
An exil of one or more of llese counlries from lle Luro, vouId maIe
aII of llis cross border debl and imporl and exporl conlracls
polenliaIIy open for renegolialion, raising queslions on lle soIvency
of financiaI inslilulions and corporalions oulside lle exiling counlry.
Tlis risI is cIearIy parlicuIarIy acule for financiaI inslilulions in
counlries sucl as Irance and Germany vlicl lave IargeIy domeslic
IiabiIilies bul disproporlionaleIy lle soullern counlries sovereign
and oller debl as assels. Bul aII Luropean banIs and oller financiaI
inslilulions are exposed lo cross border inlerbanI Iending and
sovereign debl. Tle LBA eslimaled llal around 30 of GreeI
sovereign debl and inlerbanI Iending is leId by overseas banIs. And
llal llis number is around 40 for sovereign debl for IreIand and
IorlugaI.
18
Tle exil and disorderIy devaIualion of one counlry couId
impacl lle soIvency of financiaI inslilulions in oller counlries.
Bul vill lle Ielman coIIapse, llere vas anoller probIem. Al lle
lime, il vas uncIear vleller lle soIvency of some of Ielman's
counlerparlies lad been impacled by Ielman's coIIapse. And
Ielman's coIIapse ilseIf raised issues on lle viabiIily and business
modeIs of oller pIayers. Tlese lvo faclors resuIled in a domino

18
European banking authority, 2011 EU-wide stress test, aggregate report

17

effecl as lle Ioss of confidence slifled from Ielman lo oller

financiaI inslilulions around lle vorId. Tlese oller financiaI
inslilulions, in lurn, llen faced a coIIapse in Iiquidily and so
villdrev credil from lleir reaI economy cuslomers, especiaIIy in
areas sucl as lrade finance. Tlis domino effecl magnified lle
impacl of lle coIIapse of Ielman, resuIling in a gIobaI credil
conlraclion and Ioss of confidence vlicl in lurn caused lle firsl
gIobaI recession since lle Second WorId War.
Tle exil of one counlry from lle eurozone couId lave a simiIar
domino effecl. If one counlry Ieaves lle eurozone, financiaI
marIels, specuIalors, corporalions, and even cilizens couId slarl
anlicipaling vlicl counlry couId Ieave nexl. Tley vouId move
deposils and assels oul of financiaI inslilulions in vlal lley perceive
lo be a counlry llal migll exil nexl, resuIling in a calaslroplic Ioss of
Iiquidily and credil in llese domino counlries.
The need for a Plan B
Irior lo lle Ielman coIIapse, llere vere cIearIy subslanliaI
underIying probIems vill gIobaI debl IeveIs in generaI, and vill lle
subprime morlgage and lousing marIel in parlicuIar. Tlese
probIems vouId lave been painfuI lo vorI llrougl in an orderIy
vay, bul lle disorder in lle financiaI marIels from lle coIIapse of
Ielman, resuIled in a seizing up of credil marIels, and so lad
subslanliaIIy grealer impacl on lle gIobaI economy llan vouId lave
come from an orderIy vorI oul of lle underIying probIems.
Il is evidenl llal parl of lle probIems during lle Ielman coIIapse
resuIled from reguIalors and poIicymaIers laving no conlingency
pIan in pIace for lov lo deaI vill a silualion sucl as Ielman, and
lov lo prevenl lle domino effecl as lle Ioss of confidence slifled
from Ielman lo oller financiaI inslilulions around lle vorId. Tlis
domino effecl magnified lle impacl of lle coIIapse of Ielman,
resuIling in a gIobaI credil conlraclion, near coIIapse of lle gIobaI
paymenls syslem and Ioss of confidence.
As las been slovn, lle exil of one of more counlries from lle
eurozone couId be or orders of magnilude Iarger evenl for lle gIobaI
economy. As sucl, a !iscr!cr| breaI up, beyond, say, lle exil of

18

smaII counlry sucl as Greece, cannol be aIIoved lo lappen. IoIicy

maIers need lo lave a IIan B for lov an exil can be managed.
Yolk and White countries
In Iine vill lle vording of lle WoIfson Irize Queslion, llis enlry
aIso does nol laIe a viev on vlicl counlries couId be IiIeIy
candidales lo Ieave lle eurozone, llougl lle anaIysis above slovs
vlicl counlries couId benefil mosl from a devaIualion of lleir
currency lo reslore compeliliveness. Indeed vlicl counlries are
IiIeIy lo Ieave couId be delermined as mucl by domeslic poIilics,
success of auslerily programmes and inlernaI devaIualion (incIuding
llose llal resel vage IeveIs lo beller aIign lo produclivily IeveIs) and
inler governmenl reIalions villin lle eurozone, as il viII be by
fundamenlaI economics.
As a IabeIIing convenlion, llis paper dravs from lle unscrambIing
lle omeIelle anaIogy lo use lle IabeI YoII lo describe lle counlries,
or singIe counlry llal Ieave/Ieaves lle eurozone. And Wlile for
llose llal remain inside lle Union. Tle assumplion is llal YoII-zone
counlries or counlry are llose llal require a exlernaI devaIualion lo
reslore lleir compeliliveness, vliIe Wlile-zone counlries are llose
llal are aIready compelilive or llal lave a clance of resloring lleir
compeliliveness llrougl auslerily programmes.
Tlis paper slarls by considering lle case of a singIe counlry Ieaving,
and llen exlends lle approacl lo muIlipIe counlries Ieaving. And
lle paper aIso lesls vleller lle approacles couId vorI in severaI
plases so for inslance one counlry Ieaves and al a subsequenl poinl
anoller counlry Ieaves, llougl cIearIy lle uncerlainly and cosls of a
repeal exercise viII be ligler vill a lvo slage process.
Possible endgames for the eurozone
Tle WoIfson Lconomics Irize deIiberaleIy does nol asI vleller
counlries slouId Ieave lle Luro, or vlicl counlries slouId Ieave.
Indeed, lle decision on any exil depends as mucl on lle poIilicaI
negolialion belveen counlries as on lle economics of lle Union. As
sucl, a discussion of lle differenl end games for lle eurozone is
oulside lle direcl scope of llis enlry. Hovever il is necessary lo Iay

19

oul some possibIe endgames as llese can inform some of lle Ialer
anaIysis on lov lle pc|iticc| prcccsscs can be managed around any
exil.
Tlere are llree equiIibrium endgames for lle eurozone and a
polenliaI unslabIe scenario.
1. Greater IiscaI uninn. Mucl of lle currenl commenlary on lle
eurozone crisis masIs an imporlanl facl: lle currenl eurozone crisis
is a eurozone poIilicaI Ieaderslip crisis and nol an inlerenl crisis of
lle overaII economics of lle eurozone. Tle eurozone in aggregale
las a currenl accounl baIance, fiscaI baIance and debl IeveIs
significanlIy beller llen lle US, }apan or lle UK (vill lle exceplion
of }apan's currenl accounl baIance). None of llese counlries are
experiencing probIems of a simiIar magnilude. Indeed, various
researcl efforls lave liglIiglled lov lle benefils of lle Luro in
aggregale offsel lle cosls. Tlese researcl efforls incIude an eslimale
of an annuaI benefil of over Luro300 biIIion. Hovever mucl of llese
researcl efforls, aIso slov llal lle individuaI eurozone counlries
received very differenl slares of lle benefils, vill aImosl laIf of lle
benefils accruing lo Germany.
19

A more equilabIe slaring of lle benefils couId increase lle clances
of lle eurozone lo remaining logeller, bul llis viII require a grand
bargain llal Germany, Irance and oller Luro counlries vere nol
viIIing lo slriIe prior lo lle inlroduclion of lle Luro. Germany
vouId lave lo pay a Iol more llan il vanled, Irance and oller
counlries viII lave lo concede a Iol more sovereignly llan lley
vanled.
On lle IiscaI (paying) side Germany viII probabIy lave lo accepl
some lype of joinl and severabIe IiabiIily for lle vloIe of lle
eurozone. Given lleir perceplions of lle lisloric irresponsibiIily of
some YoII counlries, especiaIIy Greece's lislory of defauIls, il viII be
a laII order for lle Wlile counlries poIilicians lo convince lleir
eIeclorales lo accepl addilionaI IiabiIily. Indeed, one of lle Iey
queslions for llis equiIibrium is vleller llere viII be a German

19
: Euro Benefits Germany More Than Others in Zone by Floyd Norris, New York Times, April 22, 2011;
Germany and the Benefits of the Euro by Antonio Fatas; Germany cashes in on Euro benefits, for now
by Annika Breidthardt, Reuters.

20

poIilicaI Ieader vill lle courage lo pul lis or ler survivaI on lle
undervriling of lle firevaIIs and inlroduclion of lransfer paymenls.
Tlere viII be a concern in lle Wlile counlries llal lle YoII counlries
couId lurn inlo an even bigger bollomIess pil as Soullern IlaIy las
been for IlaIy since lle IlaIian monelary and fiscaI union in lle 19ll
cenlury. And llal lley are facing cIassicaI poIilicaI moraI lazard
llal migll gel vorse if lley are baiIed oul.
As sucl lle inlroduclion of Lurobonds, and clanges of lle LCB
slalues lo aIIov lle LCB lo acl as Iender of Iasl resorl couId be lougl
lo aclieve poIilicaIIy even in a fiscaI union al Ieasl unliI llere is
furller progress on rebaIancing in IlaIy and Spain. Il migll be easier
lo inlroduce a banIing union, incIuding eurozone-vide deposil
insurance and banI resoIulion and supervision, and llrougl
largeled lransfer paymenls llal can be villleId if condilions are nol
mel.
20
In addilion, lle pace of inlernaI devaIualion couId be
acceIeraled llougl ligler eurozone infIalion, and furller debl reIief
for YoII counlries.
IinaIIy, a grovll compacl couId be inlroduced vill some
reIaxalion of lle currenl auslerily measures in pIace for YoII
counlries and lle inlroduclion of IeveIs of lransfer paymenls
belveen lle Wlile counlries and lle YoII counlries in Iine vill
llose seen in lle oller fiscaI unions sucl as lle Uniled Slales. As lle
anaIysis by ZsoIl Darvas in Clarl 5 slovs, lle lransfer paymenls
made belveen simiIar US regions are around 10 limes as Iarge as
currenlIy exisl belveen simiIar regions in lle LU.
21
A bacI of lle
enveIope caIcuIalion vouId suggesl llal in a IiscaI lransfer union of
lle same scaIe as lle Uniled Slales, Germany vouId need lo maIe
lransfer paymenls of around 4 of GDI, equivaIenl lo
Luro100biIIion every year. On lle bacI of lle same enveIope,
Germany vouId sliII benefil from lle Luro by around Luro50biIIion
a year, so llese lransfer paymenls couId be juslified economicaIIy.

20
For a discussion, see Euro bonds wont cure what ails Europe, by Kotz, Krahnen and Leuz.
21
Note this analysis was done for the EU and not the eurozone. Fiscal federalism in crisis: lessons for
Europe from the US by Zsolt Darvas, Bruegel Policy Contribution, July 2010

21

CHART 5
Note: CEE10: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and
Slovenia; MED5: Cyprus, Greece, Malta, Spain, and Portugal; UK&IE: Ireland and the United Kingdom;
NORD3: Denmark, Finland, and Sweden; ABLN4: Austria, Belgium, Luxembourg, and the Netherlands; Italy
(IT), France (FR) and Germany (DE) are shown separately; Gradients of lines are -0.002 and -0.002.
SOURCE: Fiscal federalism in crisis: lessons for Europe from the US by by Zsolt Darvas
-4
-2
0
2
4
6
60 63 70 73 80 83 90 93 100 103 110 113 120 123 130 133

In exclange for llis, on lle Union (sovereignly) side, Irance and
YoII counlries viII lave lo accepl lle surrender of mosl nalionaI
fiscaI sovereignly lo BrusseIs vill lle inlroduclion of some lype of
eurozone finance minislry, vill lle rigll lo rejecl nalionaI budgels,
supervision of slrucluraI reforms (Iabour marIels, pubIic seclor, lax
coIIeclion, elc.) and enslrinemenl of no/Iov deficil Iavs in nalionaI
conslilulions.
WliIe boll of llese migll sound lard lo aclieve, lle poIilicaI capilaI
llal lle eurozone eIile las invesled in lle Luro slouId nol be
undereslimaled. Il is difficuIl for many oulside lle eurozone lo
undersland lov a projecl vill sucl uncIear economic benefils and
evaIualion al lle slarl, couId lave allracled so mucl supporl. Bul
even nov vill aII lle lurbuIence, surveys slov llal 50 70 of
eurozone cilizens vanl lo Ieep lle Luro
22
. Ior many eurozone
cilizens lle Luro sliII feeIs IiIe lle rigll lisloric slep in lle rigll
direclion.
2. A smaIIer IiscaI uninn. Tle second possibIe equiIibrium end game
vouId invoIve mosl or aII of lle YoII counlries reverling lo lleir

22
Euro Isnt Loved, but Few Want to Drop It, Poll Says by Paul Geitner, New York Times, reporting the
Pew Reseach Centres Global Attitude Project.

22

ovn nalionaI currency, vill a core group of Wlile counlries

remaining in a fiscaI and monelary union. Ollers lave vrillen on
vlal migll be a sensibIe sel of counlries in llis group buiIding off
Roberl MundeII's vorI on Monelary Unions, bul llis is oulside lle
scope of lle WoIfson Lconomics Irize queslion. Tle main
uncerlainly llal llis researcl raises, vouId seem lo be vleller
Irance vouId vanl lo remain in llis union and llis is more a
queslion of poIilics llan economics.
23

3. Revert tn natinnaI currencies. Tlis llird possibIe equiIibrium
endgame vouId invoIve aII counlries reverling lo lleir individuaI
nalionaI currencies. Some beIieve llal llis abandonmenl of lle Luro
is lle onIy end game if a singIe counlry vere lo Ieave.
24

4. SingIe cnuntry exit nr perhaps "Picking them nII graduaIIy".
Tlis pall vouId slarl vill say Greece Ieaving lle Luro, and lle resl
of lle eurozone lrying lo move lovards some lype of fiscaI union.
Hovever, il is reaIIy uncIear vleller llis can be a slabIe equiIibrium
once il is slovn llal lle Luro is nol forever. As Marlin WoIf pul il
so ever eIoquenlIy in lle IinanciaI Times: . lle eurozone eiller is
an irrevocabIe currency union or il is nol. If Greece goes: An exil is
IiIeIy lo slaller faill in lle eurozone's inlegrily for ever and lle
Luro .is llen an exceplionaIIy fixed-currency syslem.
25
And ve
Inov llal fixed-currency syslems can come under allacI vill lle
veigll of specuIalive capilaI fIovs polenliaIIy forcing oller
counlries lo Ieave, in lle same vay llal lle UK vas forced oul of lle
LRM.
Hov migll llis pIay oul` IoIIoving a Greece exil and devaIualion,
companies, financiaI inslilulions and more marIel-savvy individuaIs
are IiIeIy lo fear a possibIe deparlure of a number of oller counlries,
lle redenominalion of banI accounls and bonds and a subsequenl
devaIualion. Tley vouId llerefore move lleir deposils and financiaI
assels from lle counlries concerned lo eiller Germany or oulside lle
eurozone enlireIy. Tlis oulfIov of capilaI, vlicl las aIready slarled

23
See appendix Leaving the Euro: A practical guide by Roger Bootle and Mark Pragnell, Wolfson
Economics Prize entry, April 2012. Available from policyexchange.org.uk
24
See Jens Nordvig and Neil Records Wolfson Economics Prize entries, April 2012. Available from
policyexchange.org.uk
25
A permanent precedent by Martin Wolf, Financial Times, May 17, 2012

23

(lle so caIIed banI jog), couId slarl lo reslricl lle very inveslmenl
needed by llese counlries lo move from auslerily lo grovll.
WliIe lle eurozone firevaII migll be sufficienl lo offsel capilaI fIigll
for a counlry lle size of Greece, il is Iess cIear llal lle LCB and lle
Wlile counlries couId offsel a simiIar exodus for counlries nearIy len
limes lle size sucl as Spain or IlaIy, especiaIIy if an earIier exil by
Greece lad slovn llal lle Luro is nol forever. In addilion, lle
earIier exil of Greece vouId lave made very lransparenl lle cosl of
any exil lo lle LCB and core eurozone counlries given lleir
subslanliaI exisling exposure llougl lle Luropean IinanciaI
SlabiIily IaciIily, lle Luropean IinanciaI SlabiIisalion Meclanism,
Lmergency Iiquidily Assislance, and lle Targel 2 nel cIaims of
nalionaI cenlraI banIs. Tle Iosses made by lle BanI of LngIand in
supporling lle Iound's peg in lle LRM in 1992 are a caulionary
varning in llis regard. So any LCB pIans lo creale a Iarger firevaII,
vouId face exlreme poIilicaI scruliny from counlries al lle core of
lle eurozone sucl as Germany and lle NellerIands. Il is uncIear
llal a furller increase in core counlries' exposure lo lle risI of a
furller exil vouId pass lle BiId lesl of poIilicaI acceplabiIily in
llose economies. So villoul a sufficienlIy Iarge firevaII, lle exodus
of capilaI from oller YoII counlries couId end up forcing llem oul of
lle eurozone.
Hence il is uncIear llal llis case is a slabIe equiIibrium endgame. A
IiIeIy (and unforlunaleIy IellaI) escaIalion of llis vouId be Greece,
foIIoved by IorlugaI, llen Spain, llen IlaIy. Greece's exil from lle
eurozone vouId prove llal lle eurozone is nol an irrevocabIe
currency union. Tle nexl counlry in Iine for devaIualion (IorlugaI),
vouId be escorled lo lle exil by lle marIels. Spain vouId foIIov
due lo ils banIs exposure lo IorlugaI - bul onIy afler lle eurozone
lad fougll ils Iasl leroic ballIe lo save Spain and exlausled lle
appelile for lle core counlries lo fund a firevaII. IreIand migll be
picIed up aIong lle vay. Will no more firevaII, IlaIy vouId
coIIapse afler runs on ils banIs and bonds. Will Spain and IlaIy gone
no more eurozone lle specuIalors relire lo lleir yaclls.
Tle ongoing pain of llis scenario slouId nol be undereslimaled,
parliaIIy because il couId resuIl in severaI years of massive
lurbuIence. Tle ongoing uncerlainly viII resuIl in curlaiIed

24

corporale inveslmenl, conslrained Iiquidily and rising

unempIoymenl. Tle currenlIy forecasl Iosl decade
26
of many of lle
eurozone's counlries couId become a Iosl lvo decade. Ior some, lle
impacl viII be for Ionger. Tle career prospecls viII be scarred for Iife
for lle generalion llal faced over 40 youll unempIoymenl for a
decade.
27
Lven lle UK and Sveden vlo lave anecdolaIIy aIready
slarled lo benefil from increase invard inveslmenl al lle expense of
lle eurozone, viII suffer in llis scenario given lle difficuIlies in lleir
core exporl marIel.
Wlicl of llese scenarios viII pIay oul viII be delermined by poIilicaI
cloices, negolialion and a game of brinIsmanslip as mucl as
economics. As sucl il is lard lo forecasl.

26
GDP per capita for Southern European countries is forecast by the EIU to not reach its pre crisis level
until at least 2018.
27
For a discussion see Unemployment Scarring by Wiji Arulampalam, Paul Gregg and Mary Gregory, The
Economic Journal

25

2. Aclieving an orderIy exil llrougl lle

NLWNLY approacl
Tle exil of one or more counlry from lle eurozone couId be aclieved
llrougl a surprise redenominalion in llose counlries, foIIoved by a
devaIualion. Hovever llis approacl raises a sIev of IegaI and
conlracluaI issues and is IiIeIy lo be a very regressive move vill
lle ricl and specuIalors maIing money and lle poor being lil. To
conlribule lo a debale on oller approacles, llis paper presenls lle
NLWNLY ordered approacl lo lle exil of one or more counlries.
Tlis clapler slarls by Iaying oul some crileria llal slouId be used
vlen assessing differenl approacles lo lle exil of one of more
counlries from lle eurozone. Il aIso considers lle praclicaIilies and
dovnside of a surprise redenominalion, and llen Iay oul, al a ligl
IeveI, lov lle more signaIIed NLWNLY approacl migll vorI.
Assessing different approaches to the exit of one or more states from the
Euro
Tlere are severaI vays llal one or more slales couId Ieave lle
eurozone. Tlis paper proposes eigll crileria llal couId be used lo
assess differenl approacles for lov one or more member slales
couId Ieave lle eurozone (llese crileria buiId on some of lle crileria
liglIiglled in lle various WoIfson Lconomics Irize documenls):
1. Dnes the apprnach prnvide cIarity nn hnw Eurn
dennminated cnntracts, assets, IiabiIities and snvereign
debts are redennminated in the new muIti currency regime?
Ior inslance, lov viII Ioans or conlracls evoIve vlen lley are
belveen pIayers based in lle differenl zones` So lov slouId a
Luro denominaled morlgage for a GreeI louseloId, borroved
from a German BanI be redenominaled afler separalion`
2. Hnw weII dnes the apprnach resuIt in the "matched"
treatment nI assets and IiabiIities (and suppIy and saIes
cnntracts) Inr cnrpnratinns, gnvernments and individuaIs?
Having cIarily on lov conlracls vorI in lle nev muIli
currency regime, is onIy a slarl. If lle assels and IiabiIilies of
an inslilulion (corporalion, financiaI inslilulion or even

26

louseloIds) are redenominaled inlo differenl mixes of

currencies and llese currencies llen clange in vaIue reIalive
lo eacl oller, lle soIvency of lle inslilulion couId come under
llreal. Tlis probIem is mosl acule for a number of lle banIs
vlicl lave assels (incIuding governmenl debl)
disproporlionaleIy in vlal couId become YoII counlries bul
IiabiIilies in Wlile counlries.
CHART 6
Sources: BIS
Note: excludes the impact of corporate and bank debt
1 Based on BIS data as of Q2 2011. We have not factored in complications of domestic cross-funding and inter-linked obligations for this
illustrative comparison
200 400 600 700 0


As lle Luropean BanIing Aullorily reporl slovs, 30 of
GreeI Sovereign debl and inler banI IiabiIilies are leId by
banIs oulside Greece,
28
and for counlries sucl as IlaIy lle
vaIue of debl leId oulside viII probabIy be even ligler. Tle
forced redenominalion of YoII counlries governmenl debl inlo
lle nev IocaI Luro-YoII currency and lle deprecialion of llis
currency couId resuIl in lle equily of a number of banIs being
subslanliaIIy reduced. Clarl 6 slovs lle IeveI of YoII counlry
sovereign debl leId by banIs in oller counlries. Tlese banIs
are unIiIeIy lo lave corresponding deposils in lle YoII

28
European Banking Authority, 2011 EU-wide stress test, aggregate report

27

counlries, so a 30 devaIualion in lle nev currency used for

Greece, IreIand, IlaIy, IorlugaI and Spain's sovereign debl
couId vipe oul around 30 of lle equily of banIs in llese
oller counlries. A simiIar effecl couId occur for corporalions
vill Iong lerm conlracls, for inslance, lle Iong run purclase of
Russian gas vill conlracls lo seII eIeclricily in a YoII counlry.
3. Hnw can the migratinn pace and prncess be managed sn as tn
prnvide minimaI disruptinn? Ior inslance, llere is a risI llal
lle process of separalion vouId require lle YoII counlries lo
pul in pIace capilaI conlroIs lo prevenl a fIigll of capilaI lo
financiaI inslilulions in Wlile counlries or oulside lle
eurozone. Tley migll need lo impose border conlroIs lo
prevenl banI noles being moved. Tley migll aIso lave lo
Iimil lle villdravaIs of Luro noles from banIs and laIe sleps
lo prevenl loarding of llese noles. AII of llese couId lave a
major disruplion lo normaI business and personaI aclivilies.
4. Dnes the migratinn treat individuaIs rnughIy evenIy? Tlere
is a subslanliaI risI llal any exil of one or more counlries from
lle eurozone couId be very regressive in nalure so lilling
poorer members of sociely. Ricler members of sociely are
more IiIeIy lo be abIe lo anlicipale lle separalion and
rearrange lleir finances so as lo benefil from il or al Ieasl lo
be lil Iess by, for inslance, moving lleir assels oulside lle
YoII counlries, vliIe Ieaving lleir IiabiIilies llere. As lle UK
exil from lle LRM sloved, specuIalors couId be some of lle
biggesl vinners of an exil from of one of more counlries from
lle eurozone il vas ledge funds, sucl as llal run by George
Soros, llal reporledIy made 1biIIion from belling alead of
lle UK's decision lo Ieave lle LRM
29
. In conlrasl, poorer
members of lle YoII counlries vouId lave Iess opporlunily lo
reposilion lleir assels and so vouId lave lleir veaIll lil
disproporlionaleIy.
30
Sucl a regressive move couId veII be
poIilicaIIy unacceplabIe.

29
Billionaire who broke the Bank of England, By David Litterick, Daily Telegraph, 13 Sep 2002
30
This point has been made by Nobel economics laureate Christopher Pissarides in Euro Exit Would Cost
Poor Greeks, reported by Jennifer Ryan in Bloomberg Businessweek

28

5. Hnw dnabIe is the apprnach pnIiticaIIy? Tlere are cIearIy

considerabIe poIilicaI claIIenges lo one or more member slales
Ieaving lle eurozone. CurrenlIy, lle lrealies are sucl llal lley
vouId lave lo Ieave lle Luropean Union llougl lley couId
polenliaIIy remain parl of lle Luropean Lconomic Area. WliIe
lle pc|iticc| prcccsscs are oulside lle scope of lle prize queslion
vlicl focuses on lle economic process, lle poIilicaI
acceplabiIily viII be an imporlanl crileria and so viII be
considered. In parlicuIarIy, il viII be imporlanl lo assess
vleller cooperalion is required from aII eurozone counlries
for lle exil.
6. The macrnecnnnmic eIIects nI exit incIuding inIIatinn,
cnnIidence and the eIIects nn debt. Hov quicIIy viII lle
economy of llose counlries exiling, and lle gIobaI economy
for llal maller, recover from lle slocI of an exil`
7. Dnes the mechanism, and its appIicatinn, reduce the risk nI
specuIative capitaI nutIInws? As las been discussed, llere is
a risI llal lle eurozone couId suffer from specuIalive capilaI
oulfIovs. Tle UK's experience vill lle LRM demonslrales
lle risI llal lle eurozone couId Iose conlroI of ils ovn desliny
as a resuIl of llese capilaI oulfIovs. An imporlanl lesl of any
meclanism by vlicl a counlry couId Ieave lle eurozone, is
vleller lle meclanism reduces or increases lle risI of
specuIalive capilaI oulfIovs. Tlis needs lo be boll before lle
evenl, bul aIso afler one counlry Ieaves so lov lo avoid lle
IicIing llem off graduaIIy scenario discussed above.
8. Dnes the discussinn nI an exit apprnach within gnvernments
circIes, in itseII, resuIt in destabiIising the eurnznne? Tlere
is a risI llal lle discussion of an exil approacl couId become
seIf fuIfiIIing as capilaI moves specuIaliveIy.
The impracticalities of a surprise redenomination
Many oller clanges in Monelary Unions and Currency pegs, sucl as
in Argenlina or lle exil of lle UK from lle LRM, lave been aclieved
llrougl a surprise devaIualion or disorderIy exil. Currencies vere
devaIued overnigll. Tle benefils of compeliliveness llal came from
nev IeveIs of currencies vere deIivered aImosl immedialeIy. A

29

surprise redenominalion removes lle opporlunily for subslanliaI

specuIalive capilaI oulfIovs al Ieasl reIalive lo a signaIIed or
orderIy clange llougl, as las been discussed, cIearIy some
specuIalors made significanl profils from lle UK exil from lle LRM.
Hovever, in lle case of Argenlina and lle UK's exil from lle LRM,
lle nev plysicaI currencies vere aIready in pIace, and aII llal vas
required vas a devaIualion. Il vas cIear vlal currency eacl
individuaI conlracl vas denominaled in, noles and coins vere
aIready in circuIalion, elc, even if lle vaIue of lle currency clanged.
So an overnigll clange in reIalive currencies vaIues vas possibIe,
llougl cIearIy companies, financiaI inslilulions and lle governmenl
ilseIf lad lo cope vill lle malcling issue (as described in lle
previous seclion's second crileria) from lle unequaI clanges in lle
vaIue of lleir assels and IiabiIilies or suppIy and saIe conlracls.
Tle biggesl claIIenge in pursuing a surprise redenominalion for lle
eurozone is llal lle nev currency, noles and coins do nol exisl for
lle counlry or counlries Ieaving lle Union. Companies,
governmenls and financiaI inslilulions viII aIso need lime lo clange
lleir syslems lo refIecl lle clange of some parl of lle eurozone lo a
nev currency.
Tle produclion of nev plysicaI noles and coins is one of lle grealer
claIIenges vill a surprise redenominalion. Il seems unIiIeIy llal lle
prinling of nev banI noles and minling of nev coins couId be
aclieved in secrel. Tlis prinling probIem couId be overcome by
laving banIs in lle YoII region defacing exisling Luro noles (eg
vill an inI slamp) dravn in lle YoII region.
31
Tlis vouId signaI
llal lle noles are lle nev currency, unliI lle acluaI nev YoII
currency is prinled and dislribuled. Tlis approacl couId be larder
lo aclieve for coins. And couId be very difficuIl lo poIice and vouId
be lard for vending maclines, lo be reprogrammed quicIIy lo refIecl
lle clange.

31
The approach to stamping notes, has been suggested by Eric Dor in Leaving the Euro Zone: a users
guide published in October 2011. The approach is similar to that used in the dissolution of other
currency regimes such as Czechoslovakia see Teppers A primer on the Euro Breakup, Wolfson
Economics Prize entry, April 2012. Available from policyexchange.org.uk.

30

Maybe a bigger claIIenge vouId be llal muIli nalionaI corporalions

and financiaI inslilulions vouId need lime lo adjusl lleir syslems
and accounls for lle nev currency. As a reference, lvo years vere
aIIoved belveen lle Luro exclange rales being IocIed and lle
Iauncl of lle Luro as IegaI lender, incIuding lle use of plysicaI
noles and coins. Bul preparalions for lle nev currency lad slarled
before llen, llougl llere vas aIso considerabIe focus on addressing
Y2K soflvare issues al lle lime of lle svilcl over. Given lle lime
required, an overnigll redenominalion is llerefore nol possibIe and
llere vouId need lo be some lialus period of a minimum of llree
monlls up lo lle formaI Iauncl of lle nev currencies.
During llal period, consumers, corporalions and specuIalors are
IiIeIy lo lry lo move lleir casl and savings llal viII be
redenominaled in lle nev YoII counlry currency lo financiaI
inslilulions vlere lley viII remain in Luros. Tley vouId lave an
incenlive lo villdrav and loard oId Luro noles in casl. And if
capilaI conlroIs vere imposed, as vouId seem necessary, Luro noles
couId sliII be smuggIed over lle border, llougl lle governmenls
couId lry lo force lle noles lo be redenominaled
32
. Tlese capilaI
conlroIs are iIIegaI under LU Iav, resuIling in polenliaIIy years of
Iiligalion. Il is aIso IiIeIy llal lle approacl vouId be very regressive
in nalure and resuIl in a vindfaII gain lo YoII counlry banIs (see
Ialer). Indeed, il seems IiIeIy llal lle beller informed lave aIready
posilioned lleir assels for any exil.
Il is aIso uncIear lov inlernalionaI conlracls vouId vorI vill llis
crasl redenominalion. IinanciaI inslilulions in Wlile counlries
vouId face soIvency issues as lley do nol lave malcled assels and
IiabiIilies across lle Wlile and YoII zone. AII of llis couId be very
disruplive lo economic aclivily.
So llis paper proposes an aIleralive approacl lo lov a signaIIed or
managed lransilion lo a muIli currency regime migll vorI.

32
See Greece should leave the Euro. How do you do that? by Jurre Hermans. Wolfson Economics Prize
entry, April 2012. Available from policyexchange.org.uk

31

The NEWNEY approach in concept

Tle claIIenge vill a signaIIed approacl lo one or more counlries
Ieaving lle eurozone is lov lo ensure llal, during lle period up lo
lle svilcl lo lle nev currency, deslabiIising specuIalion does nol
occur as companies, financiaI inslilulions, governmenls and
individuaIs posilion lleir financiaI assels so as lo be in lle slronger
currency. Will a signaIIed exil, llere is a cerlainly llal individuaIs
and corporalions viII villdrav lleir deposils from lle YoII counlry
banIs and bonds eiller eIeclronicaIIy or in casl. Il viII probabIy be
necessary for YoII counlry banIs lo impose conslrainls on casl
villdravaIs and lle YoII governmenls lo pul in pIace some lype of
exclange conlroIs, llougl, as las been discussed, il seems lard lo
envisage llal llese viII be effeclive given individuaIs couId IileraIIy
drive across cusloms-free borders vill suilcases of casl. A signaIIed
or orderIy approacl needs lo remove lle incenlive for specuIalive
capilaI fIovs.
Tle exisling approacl for deaIing vill llis specuIalive capilaI fIovs
is a progressiveIy Iarger firevaII. Hovever a firevaII is onIy lrealing
lle symploms of lle probIem. Inslead, llis paper proposes lle
NLWNLY approacl vlicl lreals lle rool cause of capilaI fIigll,
nameIy lle unequaI lrealmenl of differenl Luros in differenl parls of
lle Union. IndividuaIs, companies or specuIalors are moving money
oul of banIs and bonds in parlicuIar counlries Iess because of a
concern on defauIl bul because of a concern on devaIualion llis can
be seen by lle capilaI oulfIov from counlries sucl as Greece being
across lle board.
To remove lle gain (and so incenlive) for specuIalive capilaI fIovs,
ve need lo foIIov vlal ve caII lle NLWNLY principIe, llal every
Luro, vlerever il is in lle Union, or vorId for llal maller, needs lo
be lrealed equaIIy during any exil.
Tle NLWNLY approacl does llis by borroving from lle leclniques
used in a slare spin oul as opposed lo a lradilionaI currency union
redenominalion and devaIualion. Iels firsl iIIuslrale llis llrougl
one counlry Ieaving. Inslead of an approacl vlere assels in a
parlicuIar counlry Ieaving lle eurozone gels redenominaled, every
Luro inslead gels repIaced by a basIel of lvo currencies. IoIIoving
our naming convenlion, llese currencies are referred lo as lle Nev

32

Luro-Wlile (NLW) and lle Nev Luro-YoII (NLY) currencies,

and lence lle NLWNLY name for llis approacl.
Tlis approacl couId lave a number of modificalions, bul in ils
puresl form vouId be designed around lle foIIoving principIes:
1. Lvery Luro unil in lle eurozone slouId be lrealed equaIIy in
lle migralion lo muIlipIe currency regions, vleller lle
individuaI Luro be plysicaI casl, eIeclronic money, or a unil
of exclange in a conlracl, and more imporlanlIy vliclever
counlry lley are in. We caII llis lle NLWNLY principIe.
2. Tle process of migralion lo a muIli currency regime of lvo
currencies, viII be aclieved in an orderIy vay, lo aIIov lime
for corporalions lo adjusl, currency lo be prinled, and
dislribuled, elc.
3. Lacl of llese nev regions vouId lave lleir ovn cenlraI banI,
monelary poIicy, and currency unil. Tle LCB viII need lo be
mainlained for a vliIe lo manage lle lransilion and lo
supporl lle nev cenlraI banIs. Il is IiIeIy llal lle YoII
counlries viII lave ligler inleresl rales, infIalion and a
deprecialing currency reIalive lo lle Wlile counlries.
4. Lacl exisling Luro, in perpeluily, gels exclanged for a basIel
of lle Nev Luro-YoII and Nev Luro-Wlile currencies, in
fixed proporlions delermined by an exclange ralio. As an
iIIuslralion, lle exclange ralio couId be sel as 1 Luro can be
exclanged for 0.7 NLW currency unils and 0.3 NLY currency
unils. Hov llis exclange ralio migll be sel is discussed Ialer.
If lle Union vas lo spIil inlo more llan lvo regions, llis
couId aIso be aclieved by incIuding aII lle currencies for aII
lle nev currency regions in lle basIel.
5. Across lle eurozone, everyone viII lave lleir Luros clanged
inlo lle currencies in lle basIel in lle proporlions sel by lle
exclange ralio. No one is forced lo svilcl inlo any parlicuIar
currency, bul over lime, individuaIs vouId be abIe lo
exclange lle oller currencies in lleir basIel, lo lle currency
of lleir lome region. As viII be discussed, cenlraI banIs
migll need lo supporl lle exclange llrougl a one off offer or
llrougl lle provision of Iiquidily.

33

6. SaIaries and governmenl paymenls in lle YoII counlries gels

svilcled lo lle nev currency on svilcl over day al lle rale of
llal day. Any infIalion escaIalors in empIoymenl conlracls
viII need lo gel removed llis viII be a parlicuIar issue vill
Spain as 50 of firms lave aulomalic vage indexalion
meclanisms, as Roger BoolIe poinls oul in lis paper.
33
Tle
lrealmenl of llese conlracls are an exceplion lo lle NLWNLY
principIe, bul llis is required lo reslore compeliliveness.
IegisIalion migll be required in supporl of llis.
7. Tle graduaI devaIualion of lle YoII counlry or counlries
currency or currencies vouId be aclieved llrougl ligler
nominaI inleresl rales in lle YoII counlries. If lrue risI free
rales (nol governmenl rales) in lle YoII counlries are say 5
ligler llan in lle Wlile counlries, llen lle currencies vouId
be expecled lo depreciale by 5 a year. Tlis difference in
inleresl rales couId need lo be announced in advance and is
more IiIeIy lo come predominanlIy from ligler infIalion llan
a ligler reaI risI free rale. Tle graduaI devaIualion vouId
aIIov lle slarl of a process of resloring compeliliveness in lle
YoII counlries, more quicIIy llan lle approacl of inlernaI
devaIualion. Hovever il is imporlanl lo slress llal llis
devaIualion provides a slorl lerm boosl in compeliliveness
onIy if vages do nol rise al lle same rale. In effecl,
devaIualion provides leadroom for lle auslerily and
slrucluraI reform measures llal are required, bul in ilseIf is
nol sufficienl. Indeed, llis seems lo be becoming a major
misunderslood poinl among some of lle Luro exil
enllusiasls. DevaIualion is a necessary bul nol sufficienl
condilion: or lo pul il anoller vay, conlinuous devaIualion is
nol a grovll slralegy.
8. Any renegolialion of, or defauIl on, debl by llese counlries
couId aIso be managed separaleIy and subsequenlIy. Greece
las slovn lov debl reslrucluring can be managed in a
negolialed vay. Indeed, as Clarl 6 beIov from Reinlarl and

33
For details on automatic wage indexation see Figure 7 Leaving the Euro: A practical guide by Roger
Bootle and Mark Pragnell, Wolfson Economics Prize entry, April 2012. Available from
policyexchange.org.uk

34

Rogoff slovs, lle gIobaI economy las lad exlensive

experience in managing llese lypes of debl defauIl or
renegolialion.
9. Ior lle saIe of conlracls (incIuding debl) llal are currenlIy
denominaled in Luros, lle vaIue of lle Luro for lle conlracl
couId conlinue lo be delermined llrougl lle marIel exclange
rale belveen lle differenl currencies in lle basIel and lle
exclange ralio vlicl viII be sel al lle slarl. Tle exceplion of
llis vouId be empIoymenl conlracls llal need lo remain in
lle NLY so llal compeliliveness can be reslored.
34

CHART 7
60 50 40 30 20 10 0
Source: This Time is Different: A Panaromic View of Eight Centuries of Financial Crises, by Reinhart and Rogoff
1800 or year of lndependence lf laLer, 2006

Tle NLWNLY approacl meels our malcling crileria - llere viII be
no impacl on lle soIvency of financiaI inslilulions llal lave Luro
denominaled assels and IiabiIilies llal are unmalcled in lerms of lle
evenluaI region in vlicl lley end up, as lle NLWNLY approacl
las equaI lrealmenl of aII Luros. Hovever, cIearIy any defauIl by one
or more counlry couId ilseIf provide an issue for lle soIvency of
financiaI inslilulions, llougl llis is no differenl in lle currenl
eurozone sel up. Tle equaI lrealmenl of aII Luros, means llal llere is

34
Thanks to Hugo Dixon for pointing out the need to clarify this point explicitly.

35

no incenlive for capilaI lo move belveen counlries prior lo lle

eslabIislmenl of lle nev currency or for individuaIs lo maIe
villdravaIs from lleir banI accounls and loard Luro noles.
CHART 8
How the exchange ratio and market exchange rate can be
used to determine the value of a Euro in a contract


Exchange ratio set at
transition
1 Euro = 0.7 NEW (new
euro-white)
+ 0.3 NEY
(new euro-
yolk).
So everyone can exclange a Luro for 0.7 NLWs and 0.3 NLYs. Tlis
exclange ralio remains fixed. Bul lle reIalive exclange rale
belveen lle NLW and NLY clanges as lle NLY gels devaIued

Subsequenl marIel
delermined exclange
rale
1 NLW = 1.2 NLY

Tle impIicil spol vaIue
of lle Luro in a
conlracl can be soIved
for aIgebraicaIIy from
lle lvo equalions
above
1 Luro=

Or
1.14 NLY
Tlese clange as lle
exclange rale clanges
1 Luro= 0.95 NLW


Tle NLWNLY approacl aIso aIIovs conlracls llal are denominaled
in Luros lo run lleir course as lle vaIue of lle Luro (and lov llis
reIales lo oller currencies sucl as lle NLY, NLW, Iound or doIIar)
couId aIvays be delermined from lle exclange ralio and lle vaIue
of lle NLW and NLY, againsl eacl oller. Ior an iIIuslralion of lov

36

llis vouId vorI, imagine llal lle exclange ralio vas sel al 1 Luro
can be exclanged for 0.7 NLWs and 0.3 NLYs. And subsequenlIy lle
Luro YoII devaIues sucl llal nev currencies lrades sucl llal 1
NLWs is 1.2 NLYs. SimpIe aIgebra aIIovs lle vaIue of a Luro in an
exisling conlracl lo be delermined in NLWs or NLYs see Clarl 8.
A more delaiIed discussion of aspecls of lle NLWNLY approacl
foIIovs Ialer. Bul firsl llis paper expIores lle sleps llal vouId be
required lo pul lle NLWNLY approacl inlo praclice.
Key steps in the NEWNEY process
A number of sequenliaI sleps vouId need lo be foIIoved lo
impIemenl lle NLWNLY approacl:
1. PnIiticaI agreement nI hnw many mnnetary reginns wiII emerge
and setting a timetabIe Inr the prncess. Tlis vouId need lo be an
inlergovernmenlaI negolialion belveen aII lle counlries in lle
eurozone and vouId cIearIy aIso need lo slarl vill vleller
separalion is necessary al aII, and lle approacl lo be foIIoved.
WliIe lle process of separalion couId be repealed, vill oller
counlries Ieaving lle eurozone al a Ialer dale, lle cosls and
disruplions are sucl llal il vouId be beller for lle counlries lo
separale in one go. WliIe renegolialion of debl IeveIs can be
separaled from lle impIemenlalion of lle NLWNLY lransilion lo
a muIli currency vorId, il is seems cerlain llal llese vouId aIso
be parl of llis poIilicaI negolialion. A firsl slep in llis discussion
vouId be lle agreemenl of lle NLWNLY principIe llal aII Luros
gel lrealed equaIIy. We viII come bacI lo lle poIilics a IillIe Ialer.
2. EstabIishment nI centraI banks and mnnetary pnIicy cnmmittees,
deveInpment nI mnnetary pnIicies, and the designing the new
currencies Inr each nI the new reginns nr cnuntries. Lacl of lle
nev monelary regions or counlries vouId need lo eslabIisl lleir
ovn cenlraI banI, monelary poIicy process and lleir ovn
currency, incIuding lle name lo be used. Il viII aIso be necessary
for eacl counlry lo delermine a rougl largel vaIualion of lleir
currency so slouId il be in Iine vill lle Luro or in Iine vill
lisloric currencies sucl as lle Draclma or Iira` Tle IeveI of lle
currency viII be imporlanl psycloIogicaIIy as lle YoII counlries

37

use devaIualion lo reslore compeliliveness llis viII be discussed

in more delaiI Ialer.
3. Setting the exchange ratin Inr the new currencies and Iaunch nI
trading in the new currencies nn a shadnw basis. Tle process of
selling lle exclange ralio viII be discussed in more delaiI beIov,
bul viII be based on lle largel vaIualion of lle nev currency as
veII as lle anlicipaled required money suppIy and debl IeveIs for
eacl of lle nev monelary regions. Once lle exclange ralios lave
been delermined, and monelary poIicies lave become cIear,
lrading in lle currencies can slarl on a sladov basis.
4. EstabIishment nI a nne nII gnvernments spnnsnred currency
exchange nptinn. Tle governmenls of lle eurozone couId cloose
lo provide Iiquidily lo supporl vlal vouId be undoubledIy lle
Iargesl sel of exclange rale lransaclions in lislory as individuaIs
lrade lle currency lley receive in lleir basIel llal is nol lleir
lome currency. As discussed beIov, llis migll be llrougl
offering a fixed lender price for a Iimiled period al a marIel price
based on lle sladov price from lrading prior lo svilcl over
day. Hovever, il is imporlanl llal llis be on a voIunlary basis.
5. Mnve tn diIIerent mnnetary pnIicies. Once lle nev currencies
are eslabIisled, lle governmenls in lle nev regions or counlries
vouId be abIe lo pursue differenl monelary poIicies. As las been
discussed, lle YoII counlries are IiIeIy lo vanl lo lave a currency
llal depreciales over lime. Tlis couId be aclieved by laving
ligler nominaI inleresl rales and infIalion in lle YoII counlries.
6. Switch nver day. Irior lo llis dale, banI accounls and invoices,
vouId remain denominaled in Luros bul sladov lrading viII
slarl in lle nev currencies lo gel some sense of vaIue. Afler lle
svilcl over dale, lle IegaI lender for sellIemenl of paymenls
vouId svilcl lo lle nev IocaI currency. As lle Clarl 8 above
slovs, il viII aIvays be possibIe lo derive a Luro-NLW or Luro-
NLY exclange rale for conlracls and debl vill Iong duralion.
7. Redennminatinn nI cnntracts. Over lime conlracls (incIuding
Ioans) vouId gel renegolialed lo be redenominaled inlo one
currency, bul llere vouId aIvays be a faII bacI llal lle vaIue of
lle Luro as a unil of exclange in conlracls couId sliII be

38

delermined in lle nev currencies from lle vaIue of lle exclange

ralio and lle vaIue of lle nev NLW and NLY currencies.
8. Renegntiate YnIk cnuntries debt, iI needed. Tlis is nol required
for lle NLWNLY process lo vorI bul lle Greece experience lo
dale slovs llal lle IeveI of debl for some of lle Luro counlries
couId be unsuslainabIe, boll villin and oulside lle Luro. And
llis debl IeveI couId gel vorse as lleir currency devaIues given
lle debl viII be denominaled in Luros so viII need lo be repaid
in a mix of NLWs and NLYs as sel by lle exclange ralio. So il
seems IiIeIy llal some renegolialion of debl viII be required
llis viII be discussed in more delaiI beIov.
9. Winding dnwn the ECB. Tle LCB viII pIay an imporlanl roIe in
lle migralion. Over lime ils roIe viII need lo be vound dovn and
ils assels and IiabiIilies viII be devoIved lo lle counlries' cenlraI
banIs.

39

3. Specific details on the NEWNEY

approach
Tlere are a number of aspecls of lle NLWNLY approacl llal need
furller expIoralion. Tlese incIude selling lle exclange ralio, gelling
lle required foreign exclanges lo lappen, differenl monelary
poIicies, debl IeveIs and renegolialion, and lov NLWNLY couId be
appIied vill lle exil of onIy one smaII counlry sucl as Greece. A
discussion of llese viII be lle focus of llis clapler.
As las been discussed, vlicl counlry or counlries exils lle
eurozone viII be as mucl a poIilicaI decision as an economic one.
Bul delermining vlicl counlry, if any, slouId exil is nol parl of lle
WoIfson prize queslion. Hovever lo maIe lle discussion of lle
specifics more langibIe, llis paper viII iIIuslrale poinls vill lle case
lle YoII counlries or counlry exiling lle eurozone being a Iarge
counlry or sel of counlries vlicl represenls around 20 of lle
eurozone. Tlis paper viII assume, lo begin vill, llal if il is more
llan one counlry, lley viII form a nev singIe YoII eurozone
llougl llis paper viII Ialer consider lov lle NLWNLY approacl
vouId vorI vill muIlipIe regions. Tle Iey slalislics for lle nev
YoII Zone are sel oul in lle Clarl 9.
CHART 9
Illustrative data for Yolk zone exiting the eurozone
EUR BILLIONS


Eur Billions % eurozone

GDP 1,800 20%
Money supply 1,850 20%
Real economy debt 6,600 22%



40

Setting the exchange ratio

Before lle exclange ralio is sel, lle YoII governmenl(s) vouId need
lo decide vlal lle largel IeveI of lleir nev currency is. Tle eurozone
counlries lad a vide range of differenl IeveIs of lleir currencies
before joining lle Luro. A simiIarIy priced coffee couId cosl 6,000
Iiras, 6 DeulsclmarIs or 2.5 Iunls. Clarl 10 slovs lle exclange
ralios used for converling inlo lle Luro.
CHART 10
Luro convers|on rates



Belgian Franc 40.3399

Luxembourg Franc 40.3399

Deutsche Mark 1.95583

French Franc 6.55957

Dutch Guilder 2.20371

Austrian Shilling 13.7603

Irish Punt 0.78756

Portuguese Escudo 200.482

Spanish Peseta 166.386

Italian Lira 1936.27

Finnish Markka 5.94573


Source: European Central Bank

Tle YoII governmenl(s) couId decide lo maIe a cIean breaI and
relurn lo lle currency IeveIs seen in lleir pre-Luro days.
AIlernaliveIy, lley couId aim lo lave lleir nev currency lrade al
around lle same IeveI as lle Luro. Tle cloice on llis is IargeIy
driven by individuaI consumers' and vorIers' perceplions.
Il is probabIy easier for individuaIs lo lave a currency vill rouglIy
lle same vaIue as lle currenl Luro as lley viII lave gol used lo llis
IeveI. Tlere vas a popuIar beIief llal lle move lo lle Luro caused
some slorl lerm infIalion as companies rounded up lleir prices

41

llougl lle evidence on llis is Iess cIear and lle eurozone cIearIy did
resuIl in Iover infIalion for mosl member counlries in lle Iong run
35
.
Tlere migll be a benefil for lle YoII governmenl(s) in selling lle
vaIue of lle NLY al a sIigll discounl lo lle NLW so as lo slarl lle
process of regaining compeliliveness. Hovever, il couId be argued
llal selling il al a sIigll premium vouId provide marIels and
consumers in lle YoII counlries vill grealer confidence on lleir
nev currency. Il aIso migll be lard in praclice lo forecasl lov lle
IeveI viII pIay oul. Tle reIalive imporlance of llese couId be lesled
llrougl marIel researcl of consumers and vorIers in lle YoII
counlries. Il seems IiIeIy llal lle Wlile counlries viII vanl lo Ieep
lle NLW cIose lo lle vaIue of lle Luro.
Ior lle purpose of llis paper, il is assumed llal lle YoII and Wlile
governmenls largel llal lleir nev currencies slarl al IeveIs cIose lo
parily vill lle Luro.
Tle second slep in largeling lle exclange ralio is lo eslimale lle
monelary suppIy and debl (Iess doubIe counling) llal is IiIeIy lo
exisl afler lle separalion for eacl of lle lvo nev monelary areas.
Tlis is required because lle exclange ralio delermines lov many
NLWs and NLYs gel crealed from lle lransfer lo lle nev regions.
Hov llis vorIs can be slovn from an exampIe.

35
"Did Prices Really Soar after the Euro Cash Changeover? Evidence from ATM Withdrawals". Paolo
Angelini; Francesco Lippi;. Fnf Jahre nach der Euro-Bargeldeinfhrung War der Euro wirklich ein
Teuro? [Five years after the introduction of Euro cash Did the Euro really make things more
expensive?] Irmtraud Beuerlein; Did the introduction of the Euro impact on inflation uncertainty? - An
empirical assessment, Matthias Hartmann and Helmut Herwartz; source Wikipedia

42

CHART 11
Lst|mat|ng the demand and exchange rat|o
EUR BILLIONS
Pre Separation Post Separation
Euro Zone White Zone Yolk Zone Comment


Currency in
circulation
847 886 141 Need to adjust for
reserve currency
status remaining in
the White Zone and
frictional effect
Overnight deposits 3,942 3,154 788 Pro rated by GDP
and GDP multiplier
Deposits with an
agreed maturity of
up to 2 years and
deposits
redeemable at
notice of up to three
months
3,801 3,041 760 Pro rated by GDP
and GDP multiplier
Money market funds 1,185 948 237 Pro rated by GDP
and GDP multiplier




Real Economy Debt 30,000 23,400 6,600 Higher debt levels in
Yolk Zone
Less double
counting as held by
financial institutions
- 20,000 - 16,400 - 3,600 Higher bank holdings
in White Zone


Total 19,775 15,028 4,927

Exchange ratio 0.75 0.25


43

If lle exclange ralio vas sel al 1 Luro converls lo 0.8 NLWs and 0.2
NLYs, llere viII end up vill 4 limes as many NLWs in circuIalion
as NLYs. If lle demand (measured in a llird currency) for lle lvo
currencies are rouglIy in llis 4 lo 1 ralio (llis paper viII come bacI
slorlIy lo defining vlal lle demand is for currencies), llen lle
NLW, NLY and Luro viII slarl vill around lle same exclange rale.
If inslead lle exclange ralio vas sel al 1 Luro is equaI lo 0.8 NLW
and 400 NLYs, llen llere viII be around 500 more NLYs in
circuIalion as NLWs. If lle demand for lle lvo currencies are in Iine
vill lle 4 lo 1 ralio used earIier, llen lle NLY viII be in effecl
devaIued by a faclor of 2000 reIalive lo lle earIier case. And so lle
NLY vouId lave a vaIue of around lle IeveI seen for lle IlaIian Iira
prior lo lle eurozone.
So lov can lle demand for lle NLWs and NLYs be forecasl` Any
error in forecasling demand for lle lvo currencies, is nol a major
probIem as il viII resuIl in lle marIel delermined sladov price of
eacl currency diverging prior lo lle svilcl over. Tle demand for lle
currencies viII come in lvo main lypes: cIassic monelary suppIy,
and Luro denominaled financiaI inslrumenls llal are nol incIuded in
lle monelary suppIy, bul vlicl viII be redenominaled inlo lle nev
currency. Tle Ialler incIudes governmenl debl and corporale bonds,
bul probabIy excIudes mosl equily, and oller assels sucl as lousing
vlicl do nol lave a fixed principaI and inleresl obIigalion in a
parlicuIar currency. Tle reason llal debl inslrumenls need lo be
incIuded in lle caIcuIalion is because lle demand for llem is a cIose
subslilule for lle demand for NLW and NLY currency: an individuaI
vanling lo loId NLY las a cloice belveen casl, banI deposils,
governmenls' debl or corporale debl.
In doing llis caIcuIalion, il viII is necessary lo remove lle impacl of
lle doubIe counling of financiaI inslilulions loIdings of debl
inslrumenl in eslimaling lle aggregale demand. So, some banI
deposils are used lo fund lle banI's loIding of governmenl debl
bul lle aggregale end demand for a currency is lle banI deposils
and nol lle banI's loIdings of lle debl inslrumenls.
To see vly llis is lle case, consider an iIIuslralive conversion
process. Tle consumer villdravs lleir deposils from lle banI,
vlicl lle banI funds by seIIing lle bonds il loIds lo lle

44

governmenl. Tle casl llal llen needs lo be converled lo lle nev

currency is lle monelary vaIue of lle deposils, vill no conversion
requiremenl for lle bonds llal are leId by lle banIs funded by
deposils. Consider inslead, if lle governmenl bonds are leId by lle
consumer. Tlen lle conversion process is llal lle consumers seIIs
lle debl for casl. Tle casl gels converled. So bonds leId by
consumers (and corporalions for llal maller) do need lo be
converled. Hence lle demand for lle nev currency viII be driven
by cIassic monelary suppIy and Luro denominaled financiaI debl
llal are nol incIuded in lle monelary suppIy, bul vlicl viII be
redenominaled inlo lle nev currency and vlicl are nol leId by a
financiaI inslilulions lo malcl deposils.
Ior lle currenl Luro area, lle LCB eslimales llal M3 is around Luro
9.775 lriIIion
36
. Ior lle saIe of llis anaIysis, Iels assume llal llere is
rouglIy Luro 30 lriIIion reaI economy debl (so louseloId,
governmenl and corporalion) of vlicl say lvo llirds is leId by
financiaI inslilulions funded by deposils and so is doubIe counled.
An iIIuslralion of lov llese migll breaI up afler separalion is
incIuded in Clarl 9. Tlere are a fev addilionaI commenls on llis
anaIysis.
A proporlion of lle Luro money demand comes from lle reserve
currency slalus of lle Luro. In lle pre crisis year of 2008, lle LCB
eslimaled llal around 20 of Luro currency noles and coins vere
leId by non residenls. Tle number for lle US is incidenlaIIy around
50. Il couId be argued llal a subslanliaI majorily of llis is as a
resuIl of lle reserve currency slalus of lle Luro. So maybe around
Lur 160 biIIion. Il seems IiIeIy llal lle majorily of llis money viII
remain vill lle Wlile Zone currency. Tle lolaI money suppIy afler
separalion is IiIeIy lo increase by a smaII faclor because of friclionaI
effecls lle anaIysis in Clarl 9 assumes llal llis be Luro 20 biIIion.
Counlries villin lle eurozone lisloricaIIy lad differenl monelary
suppIy lo GDI muIlipIes as a resuIl of faclors sucl as differenl
reIalive uses of casl see Clarl 12 for M1. Tlese couId need lo be
laIen inlo accounl lle anaIysis on Clarl 11 las nol.

36
ECB Statistics Pocket Book, January 2012

45

Tle debl loIdings for lle YoII Zone viII be ligler llan lle GDI
spIil (20). Hovever lle offselling banI loIdings viII be more IiIeIy
sIeved lo lle Wlile Zone (in llis exampIe llis is assumed lo be
82). In llis caIcuIalion il is assumed llal debl and banI loIdings
overlime reverl lo lleir lome region currency. Tlis viII probabIy nol
be fuIIy lle case as some in lle YoII counlries migll vanl lo loId
Wlile currency as a ledge againsl excessive devaIualion. Iurller
researcl vouId be required lo undersland llis.
Once lle demand is eslimaled, il is llen possibIe lo sel lle exclange
ralio so llal lle amounl of eacl of lle nev currencies crealed by lle
svapping of lle Luros for lle basIel of currencies, is in Iine vill lle
evenluaI IeveI of demand for eacl currency (llis demand being
driven by ils use in monelary suppIy and debl) al lle largel
exclange rale. As can be seen above, llis viII lave a IillIe more of
lle YoII currency needing lo be crealed llan lle reIalive GDI
proporlions because of lle grealer debl affecling lle YoII counlries.
CHART 12
Sources: Eurostat; national sources;
0.29
0.24
0.30
0.28
0.16
0.34
0.12

Allowing FX movements and getting the exchange to happen in practice
Under lle NLWNLY approacl, aII pIayers viII receive a basIel of
lle lvo currencies in exclange for lleir Luro. IndividuaIs in lle

46

Wlile-zone viII IargeIy vanl lo lrade oul of lleir NLY currency.

And individuaIs in lle YoII-zone viII vanl lo lrade oul of mosl of
lleir NLWs llougl cIearIy lley migll decide lo relain some NLWs
as a ledge againsl a coIIapse of lle NLY or because lley are nervous
around lle NLY's prospecls.
Clarl 13 slovs an eslimale of lle nev money suppIy and debl llal
viII be crealed on svilcl over day. If lle majorily vanl lo svilcl lo
lleir lome currency, around Lur 4 lriIIion of lrading viII be required
lo svilcl over lle differenl monelary and debl inslrumenls. Tle
need lo lrade viII be parlicuIarIy acule in lle YoII Zone as lle
majorily of lle nev money received viII be lle NLWs.

CHART 13
kequ|red currency exchange
EUR BILLIONS

Pre Separation Post Separation
Euro Zone White Zone Yolk Zone

Money supply and net debt 15,028 4,927

Money Created NEWs 11,318 3,710
NEYs 3,710 1,217

CIearIy nol aII of lle debl inslrumenls viII need lo be svapped lo lle
lome currencies on day one. So nol aII of llese lrades need lo occur
immedialeIy.
Because of llis and lle facl llal lle debl and money suppIy are in
differenl proporlions in lle lvo regions, llere is IiIeIy lo be
somevlal of an imbaIance in casl lrading. In addilion, lle lrading
voIumes are aImosl cerlainIy loo Iarge lo be Iefl lo lle free marIel.

47

Tle BIS eslimales llal lle daiIy IX voIumes are around $4 lriIIion
37
,
bul llis number incIudes svaps, forvards and derivalives, and of
course is gIobaI.
To overcome llis, lle LCB (vlicl viII need lo pIay a lransilion roIe)
and lle cenlraI banIs of lle Wlile and YoII regions couId offer, for a
Iimiled period, a fixed exclange rale belveen lle currencies,
providing lle Iiquidily for Wlile and YoII companies, louseloIds
and financiaI inslilulions lo lrade lo lle oller currencies. Tlese
lrades viII be al marIel prices vlicl couId be derived from lle pre
svilcl-over day sladov price. In offering llis, il viII be imporlanl
llal llese lrades are nol compuIsory. IndividuaIs in lle YoII
counlries are cIearIy going lo be concerned llal lley end up loIding
lle NLY currency llal runs lle risI of a subslanliaI devaIualion, and
if lley llinI lley are going lo be compeIIed lo svilcl lo lle NLY
currency, llere vouId be a subslanliaI risI of exaclIy lle capilaI
fIigll llal lle NLWNLY approacl vas designed lo avoid.
So lov migll llis vorI in praclice` Lvery Luro banI accounl loIder
vouId lave lle rigll lo lave lleir Luro denominaled banI accounl
repIaced by lvo accounls. One denominaled in lle NLY and one
denominaled in lle NLW. AII Luro casl loIders vouId lave lle
rigll lo clange lleir casl loIdings converled lo lle combinalion of
NLW and NLY sel in lle exclange ralio.
Ior some corporalions and individuaIs (for inslance llose vill
louses or famiIy in boll zones) Ieeping lle lvo accounls, casl
loIdings, elc migll be lleir desired end slale. Bul for oller
corporalions and for mosl individuaIs, lley vouId prefer lo svilcl
lo lleir lome currency. So prior lo svilcl over day, lley couId be
given a cloice. Lnd up vill lvo accounls, casl loIdings, bonds. Or
lave llem svilcled lo lleir lome currency al lle Governmenl
exclange rale offered on svilcl over day. Some leclniques draving
on belaviouraI economics couId be used lo encourage svilcl over.
In lle Iension Commission's Turner reporl, lle benefils of using
inerlia or sofl compuIsion vere idenlified.
38
A simiIar approacl

37
Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2010, Bank
for International Settlement.
38
See for instance, The controversial benefits of opting out Financial Times December 1, 2005

48

couId be adopled vill banI accounls by defauIl opled inlo a svilcl

lo lleir lome currency unIess lle loIder expIicilIy opls oul.
AII Luro redenominaled bonds vouId be repIaced by lvo sels of
bonds, one denominaled in NLW and one denominaled in NLY. Tle
issuer of lle bonds couId eiller Iel lleir bonds run lo malurily in lle
currency mix. Or lley couId offer lleir bond loIder lle opporlunily
lo exclange inlo anoller mix lle fair exclange rale vouId be
dependenl on forvard exclange rales and so vouId be sIigllIy
differenl from lle Governmenl spol exclange rale described above.
Corporalions vouId decide in vlicl NLW or NLY currency or
oller currency loo sucl as lle doIIar for llal maller lley vouId
denominale lleir accounls and dividends bul as llere is no fixed
obIigalion vill dividends (as llere is vill debl inleresl and capilaI)
lley can decide llis vill inpul from lleir slareloIders bul do nol
need lo spIil lleir slocIs inlo a NLW and NLY denominaled slocI.
SlocI exclanges vouId decide vlicl currency or currencies lley
vouId use lo lrade debl and equily inslrumenls.
Tlis governmenl Luro-NLW and Luro-NLY exclange rale (and lle
forvard curves llal can aIso be derived from lle forvard NLW-NLY
curve) vouId aIso provide a reference poinl for renegolialion of
conlracls llougl llese conlracls vouId need lo be agreed belveen
lle reIevanl parlies. As las been discussed above, if lley are unabIe
lo agree lle basis for a renegolialion, llese conlracls couId conlinue
lo run vill lle Luro exclange rale derived from lle fixed exclange
ralio and lle evoIving exclange rale belveen lle NLW and lle NLY.

49

CHART 14
Cermany
lrance
Spaln
lLaly
lreland
orLugal
Creece
Sources: Bloomberg; Eurostat
lnLroducLlon
of Luro
?lelds on 10-year governmenL bonds,
Lehman
bankrupLcy
2011

Different monetary policies
Once lle separalion occurs, lle YoII counlry vouId be abIe lo foIIov
differenl monelary poIicies and slarl lo reslore compeliliveness
llougl currency devaIualion al a fasler pace llan llrougl lle
inlernaI devaIualion process. As las aIready been slaled, many
emerging marIels lave slovn llal currency devaIualion is nol, on
ils ovn, a basis for ensuring ongoing compeliliveness. SlrucluraI
clanges are needed lo aclieve lle produclivily improvemenls
required for compeliliveness, aIong vill polenliaIIy reselling vages,
enlilIemenl programmes, reliremenl ages, and culling governmenl
expendilure. Tle nalure of aII of llese clanges are fundamenlaIIy
painfuI. So lle slorl lerm boosl lo compeliliveness llal comes from a
currency devaIualion viII aIIov room lo maIe oller clanges lappen.
Tle YoII counlries can aclieve a graduaI and signaIIed devaIualion
of lleir currency by running ligler nominaI inleresl rales
39
. If lle
Wlile counlries 3 year lrue risI free inleresl rales are around 2,

39
A rise in interest rates can result in a currency increasing in value on a one off basis as capital is
attracted in. But these higher interest rate will have been announced before separation. The forward
curve for the currency would include an expected depreciation in the currency reflecting the interest rate
differential.

50

and lle YoII counlries lrue risI free inleresl rales are around 7,
llen lle YoII NLY currency vouId be expecled lo devaIue around
5 a year reIalive lo lle Wlile counlries NLW, or 15 over 3 years.
Tlese ligler inleresl rales viII aIso provide an addilionaI
encouragemenl lo inveslors lo conlinue lo loId lle NLY. Il is
imporlanl lo remember llal llis difference needs lo be measured on
lle lrue risI free rale. CurrenlIy inleresl rales aIready slov a
differenliaI llal is grealer llan llis see Clarl 14 bul llis
differenliaI is because of defauIl risIs as lle credil defauIl svaps
slov see Clarl 15.
CHART 15
Sources: Datastream, World Bank DEC Prospects Group;
Spaln
lLaly
lreland
orLugal
Creece CuS spreads on 10 year governmenL
bonds, basls polnLs
CcL 2011

Tlere are lvo claIIenges vill llis graduaI devaIualion. Iirsl il couId
enler peopIes expeclalions on infIalion and so become seIf defealing.
And second lle ligler inleresl rale couId dampen economic grovll,
assuming borrovers gel lil more llan savers. Tlis paper viII come
bacI lo lle Ialler. On lle former, llere is a risI llal infIalion
expeclalions gel raised and so saIary IeveIs rise offselling lle benefils
llal come from lle devaIualion bul, as las been discussed above,
aulomalic vage indexalion meclanisms viII need lo be removed,
and are anyvay nol prevaIenl in many YoII counlries aparl from
Spain. In addilion, vill lle currenl IeveIs of unempIoymenl seen in a

51

number of lle IiIeIy exiling counlries, llis vage infIalion risI migll
be conlainabIe.
Implications for private savings, domestic mortgages and international
contracts
Tle nalure of lle NLWNLY approacl is llal il aIIovs lle aulomalic
redenominalion of savings, domeslic morlgages and inlernalionaI
conlracls. Tlere is nol a Ioss in vaIue for savings (as measured in lle
oId Luro) as vouId lave been seen from an Argenlina lype
devaIualion.
CHART 16
Pousehold debL, C2 2011, of Cu
Sources: McKinsey Global Institute
67
87
124
105
98
48
45
62
82
94
60
81
91
0 10 20 30 40 50 60 70 80 90 100 110 120 130

IndividuaIs viII svilcl lleir savings and morlgages lo lleir IocaI
currencies, over lime. Bul again, because lle approacl lo
devaIualion reIies on ligler inleresl rales, llere viII nol be a slifl in
lle vaIue (as measured in lle oId Luro) for savings and morlgages
if lle inleresl rale is fIoaling for llese. Ior savings and morlgages
vlere lle inleresl rale is fixed, llere couId be a reduclion in lle
vaIue of YoII counlries savings and morlgages because of lle ligler
infIalion. Conlracls vouId lave a very smaII erosion of vaIue as lle
NLY devaIues because lle conlracls do nol receive lle benefil of
lle ligler YoII counlry inleresl rale. Hovever vill 20 of lle

52

basIel being in NLYs and 15 devaIualion over 2 years, llis viII be

very smaII.
As lle NLY currency devaIues and YoII saIaries (as measured in lle
oId Luro) are reduced in reaI lerms lo relain compeliliveness, one
migll expecl lo see lle YoII savings and domeslic morlgages are
vorll a grealer muIlipIe of saIaries. Tlis increase in effeclive debl
IeveIs couId be a drag on grovll. Hovever il does seem llal lle
IeveI of louseloId indebledness for some of lle IiIeIy YoII counlries
sucl as IlaIy and Greece is nol llal ligl reIalive lo oller counlries
see Clarl 16. In addilion given ligl lisloric louseloId saving rales
reIalive lo inveslmenl in a number of YoII counlries, il seems IiIeIy
llal louseloId savings are ligler and so income viII be boosled by
lle ligler inleresl rales.
Ior counlries sucl as IreIand, lle increase in louseloId debl lo GDI
viII be a conslrainl on grovll. Hovever il is aIso evidenl for llese
counlries llal lle IeveI of louseloId debl IeveI is aIready a probIem
and llal lley are IiIeIy lo need lo foIIov lle pall llal US las
aIready foIIoved lo louseloId deIeveraging, probabIy llrougl
grealer IeveIs of defauIl.
Implications for government debt
Governmenl debl faces a simiIar issue lo llal discussed above for
louseloId debl: lle devaIualion of lle YoII currencies and lle
ligler inleresl rales viII resuIl in YoII Governmenl debl groving.
And llis is unIiIeIy lo be offsel by grovll in GDI resuIling from a
boosl in compeliliveness, al Ieasl in lle slorl lerm. Tlis probIem
couId be acule for Greece, IlaIy and IreIand see Clarl 15 for currenl
IeveIs of governmenl debl.

53

CHART 17
Sources: McKinsey Global Institute
CovernmenL debL, C2 2011, of Cu
71
79
83
21
69
81
83
90
226
0 20 40 60 80 100 120 140 160 180 200 220 240

Hovever llere is aIready a mucl bigger governmenl debl claIIenge
for lle eurozone-crisis counlries llan lle increase llal couId come
from any devaIualion of lle currency. Al lle momenl, llese
counlries are slruggIing lo refinance lleir debls al an affordabIe rale,
villoul supporl from lle indirecl LCB. Tle credil defauIl svaps
suggesl a significanl probabiIily of defauIl. Tle originaI benefil llese
counlries received vlen lley joined lle eurozone of being abIe lo
borrov al lle same rale as Germany las nov disappeared. And if
some of llese counlries Ieave lle eurozone, lley viII no Ionger lave
lle supporl of lle LCB in financing lleir debl.
Any renegolialion of, or defauIl on debl by llese counlries couId aIso
be managed separaleIy and subsequenlIy. RecenlIy Greece las
slovn lov debl reslrucluring can be managed in a negolialed vay.
Indeed, as Clarl 18 from Reinlarl and Rogoff slovs, lle gIobaI
economy las a Iong lislory of managing llese lypes of debl defauIl
or renegolialion.
40


40
Reinhart and Rogoff's This Time is Different

54

CHART 18
ercenL of counLrles ln defaulL or resLrucLurlng
1
,
1 Sample size includes all countries, out of a total of sixty six, that were independent states in the given year
Sources: Lindert and Morton (1989), Macdonald (2003), Purcell and Kaufman (1993), Reinhart, Rogoff, and Savastano
(2003), Suter (1992), and Standard and Poors (various years)

The stability of the banking system
BanIs in lle eurozone face lvo separale issues: soIvency and
Iiquidily. We viII discuss eacl of llese in lurn, slarling vill
soIvency.
Tle NLWNLY approacl las been buiIl around lle principaI of
malcling. So aII banIs assels and IiabiIilies viII slarl off malcled
and so llere viII no clange in soIvency of lle banIs as a resuIl of lle
clange over lo lle nev currencies ve viII discuss beIov lov lle
aIlernalive approacl of a crasl redenominalion foIIoved by a
devaIualion couId clange lle soIvency of banIs. CIearIy llose banIs
in some parl of lle eurozone sucl as Spain llal are currenlIy
suffering soIvency issues, viII sliII lave issues afler separalion under
NLWNLY.
Tle banIing syslem's soIvency couId, lovever, be lil by any
renegolialion of debl. Bul il is uncIear lov differenl llis vouId be
vill or villoul lle exil of one or more counlry from lle eurozone.
Afler aII Greece las aIready renegolialed il debl. BanIs in lle nev
YoII regions viII nol lave lle supporl of lle LCB and so viII be

55

reIianl on supporl from lleir IocaI cenlraI banI and inslilulions

sucl as lle IMI.
Tle second issue llal banIs face is around Iiquidily. Tle villdravaI
of deposils from lle banIs migll nol be caused by concerns on lle
banI's soIvency bul on lle risI llal lle counlry migll exil lle Luro
and redenominale and devaIue. In facl lle currenl banI jog llal is
currenlIy seen in some Soullern Lurope counlries is caused by a
concern llal lle counlry migll exil lle Luro, more llan lle soIvency
of lle banIs. Inveslors are exiling governmenl bonds in a simiIar
vay. And are buying assels or maIing deposils in Germany and
oller core counlries, and oulside lle eurozone enlireIy, sucl as
Iondon properly.
41
Tle NLWNLY approacl is aimed al slopping
llis specuIalive oulfIov.
The NEWNEY with more than 2 regions
Tle iIIuslralions for lle NLWNLY approacl, so far, lave been
around lle eurozone spIilling inlo lvo regions or one counlry
Ieaving as a singIe lransilion. Hovever, lle approacl couId be
appIied if llere vere more llan one region.
Ior more llan one region, lle approacl vouId need lo be modified
so llal lle basIel of currencies llal peopIe receive in exclange for a
Luro incIude aII lle currencies. So if lle IabeI YoII1, YoII2, are
adopled lle basIel of currencies peopIe vouId receive in exclange
for a Luro vouId be
L1 NLWs + L2 NLY1 + L3 NLY2 + ..
Wlere L1, L2, L3, elc are lle exclange ralios, and NLY1, NLY2, elc
are lle nev currencies.
Applying NEWNEY with a phased exit or with a small initial exit
Tle iIIuslralions for lle NLWNLY approacl, so far, lave been
around lle eurozone spIilling as a singIe lransilion. Bul il seems llal
ve migll face lle scenario of an exil from lle Luro of a smaII

41
Nervous Europeans Snap Up London Property by Andrew Testa, The International Herald Tribune;
Foreign interest boosts prime locations, by Tanya Powley

56

counlry, vlicl for lle saIe of argumenl ve viII caII Greece. As vas
discussed in Clapler 1, if llis vas aclieved llougl a surprise exil
and devaIualion, lle eurozone couId end up al an unslabIe silualion
as capilaI fIovs oul of oller counlries in anlicipalion of lleir
subsequenl exil. Tlis couId resuIl in as oller counlries gelling forced
oul see lle above discussion on lle IicIing llem off graduaIIy
scenario.
Tle fuII NLWNLY approacl couId be appIied lo smaII exil, or even a
plased approacl lo exils, vlere one counlry Ieaves, and llen
anoller. Hovever, llis is unIiIeIy lo be praclicaI as lle cosls
associaled vill issuing lle nev currencies viII be aImosl doubIed
and lle poIilics vouId be lard lo vorI llougl. Inslead, a differenl
approacl, caIIed NLWNLY-Iile, couId be used lo aIIov lle exil of
a smaII counlry sucl as Greece. Tlis approacl relains lle NLWNLY
IrincipIe llal every Luro slouId be lrealed equaIIy. Hovever,
inslead of repIacing every Luro vill a basIel of nev currencies, a
nev paraIIeI currency is Iauncled and individuaIs are given lle
oplion of svilcling lleir savings, elc over lo il. Iel's use Deulscle
BanI's Geuro name for llis nev paraIIeI currency.
42

Under NLWNLY-Iile, Greece vouId deveIop lle design and largel
IeveI of lleir nev currency, aIong vill lle monelary poIicy, cenlraI
banI, elc in exaclIy lle same vay as vill lle fuII NLWNLY
approacl described earIier. Tley vouId pIan lo lave ligler infIalion
and inleresl rales in lle Geuro, and so vouId anlicipale a
devaIualion againsl lle Luro over lime. Tle Geuro vouId be lraded
on a sladov marIel prior lo svilcl over day. On svilcl over day,
everyone in Greece (or eIsevlere for llal maller) vouId be given lle
oplion lo svilcl savings over lo lle Geuro maybe using some of
lle inerlia or sofl compuIsion leclniques described earIier. As vill
lle fuII NLWNLY approacl, GreeI empIoymenl conlracls vouId be
svilcled over, as vouId governmenl veIfare and pension paymenls.
Over lime, compeliliveness viII be reslored llougl lle devaIualion
of lle Geuro againsl lle Luro, bul savers vlo svilcled lo lle Geuro
vouId nol suffer as Geuro inleresl rales vouId be correspondingIy

42
A variety of the parallel currency has idea has been discussed by Gavyn Davies (FT May 24); Tomas
Mayer (Deutche Bank); and Huw Pill (Goldman Sachs). However, these cases all have Greece
remaining in the Euro. With the NEWNEY-lite this would not be the case eventually.

57

ligler llan in lle Luro and so vouId offsel lle Ioss from
devaIualion. As vill lle NLWNLY approacl, Greece vouId need lo
renegoliale ils debl IeveIs and oller obIigalions sucl as llose under
paymenl meclanisms sucl as Targel2. Oller conlracls vouId be
svilcled over lo lle Geuro llougl negolialions lle defauIl being
llal lley slouId be sellIed in Luros. So for, inslance, Ioans couId be
svilcled over subjecl lo polenliaIIy a ligler rale of inleresl lo
refIecl lle fulure ligler infIalion and devaIualion of lle Geuro
currency.
Tle NLWNLY-Iile approacl vouId llerefore aIIov an orderIy
lransilion of a smaII counlry oul of lle Luro and slov commilmenl
lo lle NLWNLY principIe llal aII Luros are lrealed equaIIy. As vill
lle NLWNLY approacl, NLWNLY-Iile does nol magicaIIy maIe
debl IeveIs disappear, or maIe a banIing syslem llal is insoIvenl,
soIvenl. Hovever, il aIIovs an orderIy lransilion, and by sloving
commilmenl lo a very imporlanl principIe llal vlalever fulure
clanges in composilion of lle Luro zone, aII Luros viII be lrealed
equaIIy, reduces lle incenlive for deslabiIising capilaI fIovs. And as
a resuIl oller YoII counlries viII nol face as mucl risI of specuIalive
oulfIovs of capilaI llal couId undermine lle Luros very exislence.

58

4. Winnings and Iosers, and lle poIilics.

In llis clapler, ve viII expIore lov lle differenl meclanisms for
exil by one counlry from lle Luro viII creale vinners and Iosers. We
aIso consider lle poIilics of gelling lle NLWNLY approacl lo vorI,
as vliIe lle WoIfson prize queslion is focused on lle cccncmic
prcccsscs, lle poIilicaI processes cannol, in lle slyIe of lle economisl
on a deserl isIand, jusl be assumed lo vorI.
Evaluating winners and losers
We viII compare lvo differenl meclanisms for lov a counlry or
group of counlries couId Ieave lle Luro. Tle firsl of llese
meclanisms is lle lradilionaI surprise redenominalion and
devaIualion, perlaps over an exlended banI loIiday veeIend. Tle
second meclanism is lle NLWNLY (or NLWNLY-Iile). To maIe lle
discussion of lle specifics more reaI, ve viII conlinue vill lle
exampIe used previousIy of lle YoII counlries or counlry exiling lle
eurozone represenling around 20 of lle eurozone. Tle Iey
slalislics for lle nev YoII Zone are sel oul in lle Clarl 19.
CHART 19
Illustrative data for Yolk zone exiting the eurozone
DOLLAR BILLIONS


GDP 2,000
Overseas country liabilities, of which:
*

ECB (LTRO, ELA, etc)
Target 2
Government debt help overseas
Loans from the IMF
1,800
400
500
800
100


* Some will be via the central bank.




59

Iel's aIso assume llal in lle evenl of lle redenominalion and

devaIualion approacl, lle NLY devaIues againsl lle US doIIar by
30, and lle NLW appreciales by 10.
Hov lle differenl pIayers perform under lle lvo approacles viII be
dependenl on negolialions belveen differenl parlies so for inslance
can lle YoII Governmenl negoliale vill lle LCB, IMI and oller
Luropean governmenls lo redenominale ils debl in NLY` Hov viII
Targel 2 baIances be lrealed` Wlo viII fund a banI baiIoul for banIs
vill soIvency issues as a resuIl of cross border Iending`
Il viII aIso depend on lle pace al vlicl lle economies recover and
lle impacl on lle economies of lle slocI of lle exil. As a resuIl any
anaIysis on vinners and Iosers viII be somevlal dependenl on
assumplions economic grovll and negolialions. Tlal being said, il
vouId seem llal lle redenominale and devaIue approacl creales
more vinners and Iosers llan NLWNLY. Iels IooI al some of llem:
A Iess inInrmed YnIk saver. Under lle redenominalion and
devaIualion approacl, lleir savings viII be vorse off by
around 30 as measured in doIIars. Under NLWNLY lleir
savings viII relain lleir vaIue (rouglIy) as lle basIel of
currencies viII be around lle same vaIue as lle Luro. Ior llis
saver, lle redenominalion and devaIualion approacl is very
regressive as lle ricler YoII savers viII lave moved lleir
inveslmenls overseas.
A YnIk bnrrnwer. Under lle redenominalion and devaIualion
approacl, lleir borrovings viII be reduced by around 30.
Under NLWNLY lleir debl viII relain lleir iniliaI vaIue
(rouglIy) as lle basIel of currencies viII be around lle same
vaIue as lle Luro.
A YnIk specuIatnr. Tle YoII specuIalor viII lave moved lleir
savings offslore perlaps lo Germany or oulside lle
eurozone. Tle specuIalor migll lave even laIen oul
addilionaI Ioans from YoII counlry banIs. Tlis specuIalor
migll be an individuaI or a corporalion. Under lle
devaIualion and redenominalion approacl, lle specuIalors
gain by around 10 as measured in US doIIars, or 40 as
measured in lle nev YoII currency. Under NLWNLY, lle

60

savings of lle specuIalor relain rouglIy lle same vaIue in US

doIIars.
A YnIk cnuntry bank (nr nne with Iess YnIk assets than YnIk
IiabiIities). Lven vill a capilaI oulfIov from lle YoII counlry,
lle YoII banI is IiIeIy lo lave a ligl IeveI of YoII brancl
deposils, il viII lave some assels in lle YoII counlry bul
migll aIso lave some assels oulside lle counlry. Il is IiIeIy lo
loId some YoII Governmenl bonds, llougl llese migll lave
been pIaced vill lle LCB in exclange for an LIA Ioan. We
viII assume llal llis banI viII lreal lle currency llal il uses lo
repay lle LCB for llis repo Ioan, as lle same currency used
for lle denominalion of lle governmenl debl. As a resuIl lle
YoII banI is IiIeIy lo lave Iess YoII assels llan YoII IiabiIilies.
Under lle redenominalion and devaIualion scenario, lle YoII
banI maIes a vindfaII gain as ils assels are biased lovards lle
slronger currency. Under NLWNLY, lle vaIue of lle assels
and IiabiIilies malcl, so no gain or Ioss.
A White cnuntry bank (nr nne with mnre YnIk assets than
YnIk IiabiIities). Tle Wlile counlry banI is unIiIeIy lo lave
any YoII based deposilors (or al Ieasl llose llal admil lo
being YoII counlry deposilors) because il does nol lave a
brancl nelvorI in lle YoII counlry. Many of lle Wlile
counlry banIs viII, lovever, lave made Ioans lo YoII
individuaIs or businesses. As a resuIl il is more IiIeIy lo lave
more YoII assels llan YoII IiabiIilies. Under lle
redenominalion and devaIualion scenario, lle YoII banI
couId maIe a Ioss as more of ils assels gel redenominaled inlo
lle veaIer currency llan ils IiabiIilies. Under NLWNLY,
clanges in lle vaIue of lle assels and IiabiIilies malcl so no
gain or Ioss.
The YnIk gnvernment. Tle YoII governmenl is IiIeIy lo
redenominale ils debl inlo ils nev currency. Some of lle lerms
of lleir debl migll be sel up so llal lleir debl viII remain in
Luros bul a subslanliaI proposilion of lleir debl viII be
redenominaled. In addilion, lley are IiIeIy lo redenominale
lle IiabiIilies of lleir cenlraI banI lo lle LCB under Targel 2
inlo lleir nev IocaI currency. As a resuIl lley viII lave up lo a

61

30 reduclion in lleir debl under lle redenominale and

devaIue process. Under NLWNLY, lley vouId lave a smaII
reduclion in lleir IiabiIilies over lime as lle NLY devaIues,
assuming llal lley are abIe lo negoliale a clange of lleir
IiabiIilies lo NLY on svilcl over day al lle svilcl over dale
marIel rales, bul villoul lle corresponding increase in
inleresl rales for lleir inleresl bearing debl cIearIy Targel 2
baIances are nol inleresl bearing.
The ECB. Tle LCB viII be exposed lo clanges in lle YoII
currency llougl ils Targel 2 obIigalions as veII as ils Ioans lo
YoII counlry banIs, secured againsl repos on governmenl
bonds. Under lle redenominalion and devaIualion approacl,
il viII maIe a 30 Ioss on ils Ioans. Under NLWNLY, il migll
suffer from a graduaI Ioss during lle period of devaIualion if
lle YoII governmenl is abIe lo negoliale a clange of lleir
IiabiIilies lo NLY on svilcl over day al marIel rales bul
villoul lle corresponding increase in inleresl rales.
Tle anaIysis above slovs llal a redenominale and devaIue
approacl creales major vinners and Iosers. SpecuIalors, YoII BanIs,
YoII borrovers and lle YoII Governmenl, aII receive a vindfaII
benefil al lle expense of lle Iess advanced YoII Saver, lle Wlile
BanIs and lle LCB. Tle NLWNLY approacl is more neulraI in llis
regard.
Nov cIearIy some of lle vindfaII benefils couId be offsel llougl a
vindfaII lax, as suggesled by NeiI Record in lis WoIfson enlry. Bul
villoul llal, lle defauIl and devaIue approacl creales vindfaII
profils for some.
The politics
Tlere are considerabIe poIilicaI claIIenges in negolialing for any
counlry or counlries lo Ieave lle Luro. Any open discussion on an
exil runs lle risI of acceIeraling capilaI fIigll, and so couId
precipilale lle need lo exil.
Hovever, a uniIaleraI exil by one counlry can be aclieved villoul
aII members of lle eurozone agreeing, by lle exiling counlry
vaIIing avay from ils lrealy obIigalions. Tley migll end up being

62

slul oul of gIobaI capilaI marIels for years and even oulside lle
Luropean Lconomic Union, bul lley can maIe a uniIaleraI decision
lo exil. Of course, lle economic consequences for lle resl of lle
gIobaI economy of llis uniIaleraI decision vouId be severe.
Tle fuII NLWNLY approacl requires aII members lo agree lo lle exil
and some are passionale aboul preserving lle eurozone and lave
significanl poIilicaI capilaI invesled. ImpIemenling lle NLWNLY
approacl is llerefore parlicuIarIy claIIenging in llal il requires
commilmenl and agreemenl from a Iol of parlies. Hovever, vliIe
llis is a disadvanlage, lle reaIily is llal lle probIems of lle
eurozone needs lo be soIved by a broad based discussion and
agreemenl. A GreeI exil on ils ovn migll resoIve some of Greece's
probIems bul vouId cause a Iol of oller ones in IorlugaI, Spain,
Germany, elc. Tle Luro area needs lo come up vill an agreemenl on
a loIislic approacl.
Al lle learl of any decision maIing on llis viII be Irance and
Germany. Irogress lovards Luropean inlegralion vas driven by
Irance and Germany vill lle Irencl aIvays conceding a bil more
sovereignly llan lley reaIIy vanled and lle Germans aIvays paying
a bil more llan lley reaIIy vanled. Hovever, neiller lle poIilicaI
eIile nor lle eIeclorales vere al llal lime of lle inlroduclion of lle
Luro prepared lo go aII in lovards a fuII fiscaI union vill joinl
and severabIe IiabiIily and lle surrender of nalionaI fiscaI
sovereignly. Tlis viII be a core parl of lle ongoing negolialion
belveen Irance and Germany.
So lov migll an impIemenlalion of lle NLWNLY approacl come
aboul` Il seems IiIeIy llal lle firsl slep vouId be an agreemenl of
lle NLWNLY principIe llal aII Luros gel lrealed equaIIy. Tlis migll
slarl llrougl a slalemenl made by Germany commilling lo lle
NLWNLY principIe, perlaps as parl of a Luro summil. WliIe lle
discussions in preparalion for llis vouId need lo be leId in secrel, il
is a Iol Iess of an expIosive discussion llan lle discussion of a
specific counlry exiling.
Tle agreemenl lo lle NLWNLY principIe, is IiIeIy lo be precipilaled
by one of a number of exlernaI evenls llal viII lrigger a crisis. Ior
inslance, an exisling member of lle eurozone couId uniIaleraIIy

63

decide lo exil - for inslance llis migll afler lle }une 17 eIeclions in
Greece. AIlernaliveIy, lle LCB and lle eurozone Ieaderslip couId
decide lo expeI a counlry because, for inslance, lley defauIl on lleir
auslerily commilmenls, so no Ionger are eIigibIe lo receive supporl
from lle LCB and so are become in defauIl on lleir debl. Maybe
mosl IiIeIy, lle crisis viII be lriggered by a massive capilaI oulfIov
(lle banI jog becoming a banI run) vlicl viII be loo mucl for
lle currenl firevaIIs. Tlis vouId lrigger an emergency meeling
around increasing llem, vill German labIoids sucl as BiId and
oller papers coming oul in opposilion lo any furller German
commilmenl. Tle negolialions around agreeing lo increase lle
firevaII, vouId slruggIe, and inslead lle NLWNLY principIe couId
be agreed lo, aIong vill possibIy a Luro vide banI insurance
scleme.
Agreeing lo lle NLWNLY principIe is aIso easier for lle eurozone
core llan agreeing an exil roule because vliIe il does admil llal an
exil is possibIe (and so llal lle Luro is nol forever), il does nol
commil lo a counlry Ieaving. Indeed, agreeing lle NLWNLY
principIe is polenliaIIy, besl vay of supporling lle Luro Zone
remaining inlacl.
Once lle NLWNLY principIe is agreed lo, lov migll aII lle
members of lle eurozone aII agree lo lle NLWNLY approacl for an
exil` If ils jusl one counlry sucl as Greece exiling, NLWNLY-Iile
approacl couId be aclieved vill a reIaliveIy smaII biIaleraI
agreemenl.
NLWNLY requires more agreemenl, so a grealer claIIenge. Bul ils
aIso imporlanl llal a number of counlries maIe lle decision on a
permanenl basis on vleller lo slay in or exil lle Luro cannol face
an ongoing peeIing of lle onion as counlries are picIed off. Tlis
decision viII laIe some lime lo maIe and may even go lo a
referendum. Tle benefil of agreeing lle NLWNLY principIe is llal
sufficienl lime can be aIIoved for llis debale and negolialion can be
done villoul lle risI of capilaI fIovs.
Wly migll lle core counlries of Germany and Irance accepl
NLWNLY` Tle firsl argumenl is llal lle NLWNLY approacl
provides grealer slabiIily llan lle crasl exil. A crasl exil vouId be a

64

grealer slocI llan Ielman and couId require mosl of lle eurozone's
banIs lo be nalionaIised as lley viII be insoIvenl. Tlis viII be
parlicuIarIy appIicabIe il lle exil vere lo be more llan jusl a smaII
counlry sucl as Greece. In addilion, llere is a risI llal lle exiling
counlry couId llrealen lo vaII avay from some of ils debl
obIigalions, or ils obIigalions lo lle LCB. Tle Ialler migll be
aclieved by lle exiling counlry issuing ils ovn currency, svapping
il for Luros, and using lle Luros received lo repay ils debl
obIigalions. Tlis llrealened approacl couId be sufficienlIy
disruplive llal aII members of lle eurozone agree lo lle NLWNLY
managed exil. IinaIIy, il is IiIeIy llal Germany viII lave become
lired of lle ongoing game of poIilicaI brinIsmanslip so migll
veIcome a move especiaIIy if llis is lo a sIimmed dovn eurozone.
Tley migll remember lle German proverb as poinled oul by
Gideon Raclman: Beller an end vill lorror, llan lorror villoul
end.
43


43
Time to plan an velvet divorce by Gideon Rachman, Financial Times.

65

ConcIusions
Tlis documenl las been vrillen as a conlribulion lo lle debale for
vlal migll be a IIan B in case one of more counlries decided lo
Ieave lle eurozone. Bul lle approacl aIso acls as a meclanism for
lle eurozone removing lle risI of specuIalive allacIs llal couId
undermine lle ongoing exislence of lle eurozone.
Tle NLWNLY approacl provides an aIleralive lo lle crasl
redenominalion and devaIualion approacl. Il aIso does reIaliveIy
veII al meeling lle crileria Iaid oul above:
1. Dnes the apprnach prnvide cIarity nn hnw Eurn
dennminated cnntracts, assets, IiabiIities and snvereign
debts are redennminated in the new muIti currency regime?
Tlese can be derived from lle NLW-NLY exclange rale and
lle iniliaI exclange ralio. Or lle conlracl can be sellIed vill a
basIel of lle nev currencies.
2. Dnes apprnach resuIt in "matched" treatment nI assets and
IiabiIities (and suppIy and saIes cnntracts) Inr cnrpnratinns,
gnvernments and individuaIs? Tlis is aclieved because of lle
equaI lrealmenl of aII Luros.
3. Hnw can the migratinn pace and prncess be managed sn as tn
prnvide minimaI disruptinn? Tle separalion of one of more
counlries from lle eurozone viII aIvays be a painfuI process.
Tle NLWNLY approacl is more disruplive in llal il impacls
lle vloIe Union. Hovever il removes lle risI of ongoing
disruplion from specuIalive casl fIovs. NLWNLY-Iile can
operale vill Iess disruplion.
4. Dnes the migratinn treat individuaIs rnughIy evenIy? Tle
equaI lrealmenl of aII Luros aclieve llis. Tle approacl is nol
regressive.
5. Hnw dnabIe is the apprnach pnIiticaIIy? Tlere are cIearIy
considerabIe poIilicaI claIIenges lo one or more member slales
Ieaving lle eurozone. Tle claIIenge vill lle NLWNLY
approacl is llal il requires aII members lo sign up. Hovever,
as las been discussed above, agreeing lle NLWNLY principIe
as a firsl slep is more doabIe.

66

6. Impact nn macrnecnnnmic eIIects nI exit incIuding inIIatinn,

cnnIidence and the eIIects nn debt. Tle NLWNLY approacl
prevenls lle lype of slocI llal couId sIov lle gIobaI economy
for a decade. Il aIIovs lle YoII counlries lo devaIue, llougl in
a more deIiberale vay. As il does nol creale vinners and
Iosers, il viII probabIy resuIl in fever banIruplcies.
7. Dnes the mechanism, and its appIicatinn, reduce the risk nI
specuIative capitaI nutIInws? Tle NLWNLY principIe and
approacl came from an inveslor vorIing oul lov lo posilion
a porlfoIio lo benefil from an exil of one or more counlry. Il
vas designed so as lo nol aIIov specuIalive posilions lo
benefil, lence il slouId radicaIIy reduce lle risI of specuIalive
oulfIovs.
8. Dnes the discussinn nI an exit apprnach in gnvernments in
itseII, resuIt in the destabiIising nI the Uninn. As lle
approacl does nol provide any benefil lo specuIalive capilaI
fIovs, lle discussion does nol deslabiIise lle Union.
Lven if lle eurozone is expecled lo remain logeller, poIicymaIers
need a IIan B for lov one or more counlries couId Ieave lle
eurozone. NLWNLY provides some componenls llal couId be
incIuded in llis pIan. Bul lle NLWNLY approacl couId aIso supporl
lle eurozone remaining logeller as il reduces lle risI of specuIalive
capilaI fIovs llal couId deslabiIize lle Union. So paradoxicaIIy, a
pIan llal vouId aIIov a member slale lo Ieave lle eurozone, couId
aIIov lle Union lo remain logeller. Tle reaI pover of NLWNLY
migll come from il never being used.

67

Biograply, conlacl delaiIs and

acInovIedgemenls
Catherine Dobbs
Callerine received a BA in engineering from Oxford Universily. Sle
subsequenlIy vorIed in quanlilalive researcl al NalWesl
Inveslmenl Managemenl and Garlmore Inveslmenl Managemenl,
deveIoping invesling and lrading aIgorillms. Sle nov divides ler
lime belveen lle Soull Korea, TlaiIand and lle UK, and is an aclive
personaI inveslor.
Sle can be conlacled al callerineIdobbsgmaiI.com
Acknowledgements
Tle aullor vouId IiIe lo acInovIedge lle inpul and guidance sle
received from a number of peopIe in finance, economics, poIicy and
academia, aII of vlom slared lleir insiglls in a personaI capacily.
WliIe a number viII lave lo remain anonymous, sle vouId IiIe lo
pubIicIy llanI:
Martin BaiIy, a senior feIIov al lle BrooIings Inslilule and
former clairman of lle US CounciI of Lconomic Advisers
during lle CIinlon adminislralion. Marlin las a IlD from
MIT and gradualed from Clrisl's CoIIege, Cambridge vill a
bacleIor's degree in economics.
Sir David CIementi, lle Clairman of Virgin Money and
Warden of Winclesler CoIIege. He is a former Depuly
Governor of lle BanI of LngIand and vas Clairman of
IrudenliaI pIc. David vas educaled al Winclesler CoIIege and
IincoIn CoIIege, Oxford, vlere le oblained a degree in
IoIilics, IliIosoply and Lconomics and a bIue for allIelics.
Rick LaciaIIe, GIobaI Clief Inveslmenl Officer of Slale Slreel
GIobaI Advisors. RicI vas previousIy al Garlmore Inveslmenl
Managemenl. He las a BSc in OperalionaI Researcl from
Iancasler Universily and MSc in Lconomelrics from Iondon

68

GuiIdlaII Universily. He is Clairman of lle Board of Inquire

(UK) a non-profil body devoled lo lle researcl and promolion
of quanlilalive leclniques in inveslmenl managemenl, a
member of lle ITSL IoIicy Commillee and le sils on lle
Assel Managemenl Commillee of lle Inveslmenl Managemenl
Associalion.
Hans Peter Maassen, a parlner of Argos a Municl-based
company llal focuses on lle acquisilion and aclive
managemenl of SMLs, mainIy in German speaIing counlries.
Ieler las a MBA in Business Adminislralion from Slanford
Universily, a Il.D. in Clemislry from lle Max-IIancI-
Inslilule and a M.Sc. in Clemislry from lle Universily
KaisersIaulern.
MichaeI Spence, a senior feIIov al Slanford Universily's
Hoover Inslilulion and a facuIly member of Nev YorI
Universily Slern SclooI of Business. He is lle former Dean of
lle Slanford Graduale SclooI and former Clairman of lle
Deparlmenl of Lconomics al Harvard. MiIe sludied al
Irincelon Universily and MagdaIen CoIIege, Oxford. In 2001
le vas lle recipienl of lle NobeI MemoriaI Irize in Lconomic
Sciences.
Tle aullor aIso benefiled from pubIic commenls on ler earIier
submission from a number of academics and journaIisls, in
parlicuIar Riclard BaIdvin (of Vox), Ieler Coy (of BIoomberg
Business WeeI), and Hugo Dixon (of Reulers BreaIing Vievs).
My llanIs lo aII of llem.