An idiot’s guide to leaving the Eurozone

By Luke Prescott

c/o sagabaradon

It never quite went away, but the sobering debate of Greece’s exit from the Eurozone has hit markets hard. Since the entire Eurozone can be described as struggling, with the exception Germany, what is happening in Greece can be said to be economic failure.

Those marathon talks about a Eurozone fiscal compact last December failed to confound the pessimism of markets worried about holdings not just in Greek banks, but also in Spanish, Portuguese and Italian banks.

A messy election and no clear winner has left the Greek President, Karolos Papoulias, to appoint an interim government and arrange fresh elections for mid-June (which is also the date Greece is due to receive new bailout funds). Greece is now at an impasse; does it stay or does it go? Either route involves social, financial and political turmoil and further suffering for the Greeks.

Germany, the rest of the Eurozone and the markets would strongly favour Greece to stick with the Euro which sets the scene for a standoff between Merkel and the likely leader of the Left Coalition Greek coalition come June; Alexis Tsipras. This coalition has pledged to shake off the austerity measures required to gain new bailout funds. Merkel is unlikely to agree to any deviation of such measures at the risk of a backlash amongst German taxpayers heading to the polls next year.

So how does a member of the Eurozone exit? Can economies leave the Eurozone but stay within the EU, or do they need to reapply? What protocol or legislation exists for such a situation?

A poorly publicised paper in fact exists, which was released in October 2011, and within it, Eric Dor provides an insight into how events could transpire, should such an exit occur.

Adhering to current law, the only way Greece could exit the Euro and the EU as a whole would be to use Article 50 of European treaty regulations. It would then negotiate membership back into the EU. Or Article 50 could be amended to allow Greece to exit the Euro, but stay in EU. As with all things European, such an amendment would require ratification from every member state and would be far too slow a reaction.

Therefore, the most likely scenario to keep up with market reactions would be to gain agreement by the entire European Council, which could issue a new regulation allowing Greece to withdraw from the Euro quickly – the legal issues would be discussed and dealt with afterward.

A difficulty would be that Greece would leave the Euro alone, and so all current business contacts and inter-EU debts could not be immediately converted as no exchange rate exists. Add to that the expectation that a Greek Drachma could only depreciate against the Euro in the short and long term, which makes for sobering process.

Steps would therefore need to be taken in order to avoid panic which would very quickly spread through the rest of the Eurozone, and beyond. The managing director of the IMF, Christine Lagarde stated on 15 May 2012 that the Euro should be ‘‘technically prepared for anything”. ‘Technical preparation’ could be blocking saving accounts and even an illegal capital control within the wider EU to limit the circulation of capital within the European free market.

Legality

Some regulations may have to be ignored in order for the European Council to react quickly enough. Obviously, the UK benefits from EU membership without being a member of the Eurozone, but all countries now joining the EU must sign up to the Euro. Article 50 only allows for a full divorce from the EU, and not a selective one.

International Law is a useful here, as it would allow the Greeks to leave the Eurozone of their own accord (without EC involvement) but remain in the EU. Dor points out that the Vienna Convention on the Law of Treaties allows any sovereign nation to suspend or withdraw from any international treaty of their choosing (even in the case of the Eurozone, which does not contain a ‘get-out’ clause).

The convention also stipulates that clauses within an international treaty can be withdrawn from whilst remaining within the treaty (the EU itself) overall – this appears to be the only legal way for Greece to withdraw from the Euro, but to remain within the European Union.

The fall-out of abandoning the Euro

When countries first joined the Euro, they did so together, from old established currencies into a shared currency which provided an easy and simple conversion of trade contracts, and inter-governmental debt. A sole nation leaving in a panic, from an established currency into a completely blind and new currency would allow no way to convert holdings, contracts or debt. There is simply no way to relatively convert from the Euro to a new Drachma.

Debt is main question here, Greece currently holds billions of the €644 billion Germany’s Central Bank has so far lent to struggling Eurozone nations and banks. As the receiver, would Germany want to receive their repayments in Euros or Drachmae?

The Greeks as borrowers would prefer to pay in Drachmae (which would be very weak against the Euro), and the Eurozone lenders would wish to be paid in Euros to get more back. According to the principle of lex monetae, as the lending state, Germany would have the final say on which currency would be used: more bad news for the Greeks.

Since the Greek national and domestic banks would have their holdings frozen and then converted to the severely depreciated and weak Drachma, they could quickly go bankrupt.

Again, with no real way to establish an exchange rate between the two currencies, panic would ensue and money would be quickly pulled out of banks in Greece, and the banks that lent to them – possibly causing another credit crunch. Was this why the IMF was fundraising recently?

Dor sets out the following step-by-step process to follow;

1. As the secessionist, Greece would need to freeze accounts of both domestic and national banks for all residents (foreign holdings would not need to be frozen).

2. The foreign holdings would instead be converted at a 1:1 ratio of Euro:Drachma and this also applies to all loans from the ECB and other national banks and organisations.

3. Trading would open on the foreign exchange market of the new currency, where the Drachma would quickly depreciate. But this depreciation could be measured, and used to provide an accurate conversion rate.

4. The frozen domestic accounts would be used to buy sovereign bonds in order to stop the new currency devaluing too much against other currencies. The free market and free exchange of capital within the EU could also be temporarily and illegally frozen.

5. On a more practical note, Euro notes would be stamped to state they were worth only what they could be converted into in Drachmae. Those who still keep their savings under their mattresses would have an amnesty period whereby they could go to currency shops and have their notes stamped for use as temporary legal tender.

6. The wait for new Drachma banknotes and coins would then begin.

Which ball in and in whose court?

It seems that whether Greece stays or goes, an uncertain and difficult future awaits Greece, the Eurozone and the EU. Difficult negotiations are ahead. The best outcome would be to keep Greece within the Euro currency, if only as a firewall to prevent markets turning their attention to the much larger and equally worrying economies of Spain, Italy and Portugal.

Concessions to austerity will need to be made in order to keep the next Greek government willing to adhere to the fiscal pact. On the other hand, the markets and rating agencies will circle like vultures at any deviation from this pact, which could hint at a possible Greek default. Not only this, but Merkel is aware of the upcoming election and angry German taxpayers. With recent gains for Socialists in Europe, Merkel will be incredibly wary of allowing the loss of hard-earned German tax money.

Francois Hollande and Merkel met on 15 May 2012 for their first euro talks in Berlin. Hollande suggested that ‘everything is on the table’ – including Eurobonds – that were originally rejected by Germany. Hollande stated, “I want to renegotiate what was accepted at a certain stage to give it the dimension of growth”.

A happy middle ground needs to be reached by Merkel and Hollande for the benefit of Greece, the rest of Europe, and the markets. Perhaps, it would be best to stick with the rigid budget guidelines agreed in March 2012 but also to free up funds to alleviate joblessness in Europe and the corrosion to living standards in Greece caused by this unflinching budgetary discipline.

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