Wednesday, March 25, 2015


Si vis pacem, para bellum – If you want peace, prepare for war, said Vegetius in the 5th-6th century b.C.  Just as then, and by the same token, Si vis euro, para exitum: if you want to keep the euro, prepare for exit.

In 2012 Willem H. Buiter and Ebrahim Rahban, respectively chief economist and global economist of Citygroup, writing in the Market Insight section of the Financial Times (Greece far from safe even after debt swap, 13 February), coined the word Grexit – a euphonic synthetic neo-logism for Greek exit from the Eurozone.  They wrote then:

There is some good news. Plentiful ECB liquidity has pushed back the risk of disorderly default of systemically important euro area banks and, combined with financial repression in euro periphery nations, has eliminated the near-term risk of a disorderly default by a systemically important sovereign. The external damage caused by a Greek euro area exit (or ‘Grexit’, as we call it) could, given appropriate policy response from the ECB and euro area creditor countries, be limited and need not trigger waves of “exit fear contagion” to other fiscally weak peripheral countries. The second LTRO on February 29 may buy more time but until the fundamental drivers of the euro area sovereign debt and banking crises are addressed, volatility will remain a constant companion and recovery and growth absent friends”

Since the unexpected victory of Alexis Tsipras and his Syriza Party, elected on 25 January 2015 on a programme rejecting European austerity and its embodiment the Memorandum imposed by the Troika (EC, ECB and IMF) on the Samaras government, references to Grexit have become increasingly frequent, including its variation Grexident (Wolfgang Schauble) to indicate the possibility of Greek “accidental” exit, in spite of neither the Greek government nor European authorities (perhaps not including Schauble) actually wanting to provoke that event.

Three observations are in order.

1) There are serious legal problems involved in Grexit. 

For a start, there is no legal provision in the Treaties for an EMU member state to withdraw from or be compelled to leave the Eurozone. The decision to introduce the euro is “irrevocable” (Art. 140 TFEU).  The same was true for the EU as well. Article 50 TEU, however, grants EU member states the right to withdraw from the European Union. It is inconceivable, though it has not been explitly stated, that a country could leave the EU and still maintain all the rights reserved to EMU members. Conversely, membership of the EMU is part of the obligations of membership, the so-called acquis communautaire, unless a derogation had been successfully negotiated in 1992 at the time of signing the Maastricht Treaty.  Therefore a State that left EMU or, by some unspecified measure, was no longer a member of EMU would have to leave the EU as unable to fulfil its membership requirements.  And even if a country was allowed such a derogation ex-post, thus maintaining EU membership, it would still be subject to the fiscal straightjacket of the so-called Growth and Stability Pact and the Fiscal Compact, i.e. the exit from EMU would not restore a country’s fiscal sovereignty.  Unilateral exit from the EU would take effect only two years after its declaration, but we must presume that exit from the EU of an EMU member would involve its immediate exit from the Monetary Union.  The immediate implementation of capital controls and ceilings on cash withdrawals from banks, in order to avoid capital flight and bank runs, would certainly follow. That the Council, the European Parliament and the relevant Greek institutions would have to be consulted beforehand would also and detrimentally make secrecy impossible.

2) Grexit would involve the problems of managing the new currency. 

The rate of conversion of the old into the new currency would have to be identical, at least to start with, with the rate of conversion of euro prices and wages into the new currency. Without loss of generality therefore at time 0 the new currency could be initially issued at par with the euro.  Immediately afterwards, however, the exchange rate between the old euro and the new currency, let us call it the drachma, would necessarily have to be floating, fully determined by the market. At any managed exchange rate different from the market rate Gresham's Law would operate: “Bad money [i.e. the currency overvalued with respect to the market rate] drives out good [the undervalued currency]”. One of the oldest economic discoveries, anticipated in 1519 by Copernicus, even earlier by Nicole Oresme in the fourteenth century, the law was first stated clearly by Aristophanes in his play The Frogs, around the end of the fifth century b.C.

The new currency would have to be devalued, very soon after issue, for the exiting country to obtain the benefits of greater international competitiveness and devaluation of debt payable in that currency.  (Wolfgang Munchau expects the new currency to continue to circulate at par with the euro voluntarily on a significant scale, but this is unrealistic). However the currency to be used for discharging earlier obligations cannot be chosen at will; it is determined by the law of the country where the transaction has taken place.  Thus, for instance, much and probably most of the outstanding import and export orders, as well as past unpaid tax, and the servicing of already existing debt will have to continue to take place in euro, under penalty of default; overall, something like 30% of debt and almost all of derivatives trade. Target 2 large balances – a purely technical construct while the euro lasts – would become real and would have to be settled or canceled, coming to a head.  And furthermore Dual currencies are always a bad idea” (this Blog, 10 February 2010).  

Euro denominated obligations contracted under the law of a non-Eurozone country like Britain will have to be discharged by converting the new currency into euros at the market exchange rate.  Thus the introduction of the new currency would not avoid default, it would simply be the form that a default would take.  As well, a default would involve the inability to access international financial markets for the next 10 or 15 years and/or a much higher cost of finance.

The devaluation of the new currency would necessarily involve an acceleration in inflation with respect to euro inflation, and therefore an increase in the interest rate with respect to euro rates, and especially a higher spread with respect to German Bunds. The impact of the new currency on external accounts, income and employment, will depend both on its subsequent impact (“pass-through”) on the path of wages and prices inflation, and on trade elasticities of both demand and supply; in principle perverse effects cannot be ruled out.  In the end the success of a euro exit would depend on the flexibility of real wages and prices, as well as on the country’s ability to implement productivity-enhancing policies, which are the same conditions under which the maintenance of a common currency would work.

3) Grexit would never be accidental.

Grexit would be the result of a deliberately destructive strategy adopted by Germany and the Nordic countries (Finland, the Netherlands, France, the Baltics) aided and abetted by Spain and Portugal for fear of opposition parties ousting their governments should Syriza’s example succeed, and by Italy out of perceived self-interest.  The Greek refusal, backed by the new elected government and today reportedly supported by 80% of the Greek population, to continue with the self-defeating, ruinous austerity policies imposed from Brussels, Frankfurt, Berlin and Washington, is a completely rational and democratic choice rather than the reckless strategy in an irresponsiblee game of “chicken” of which Greece has been accused. 

The most likely course of events leading to Grexit would be: the continued denial of Greek access to any of the €7.2bn residual funds provided by the Troika’s earlier rescue package, while Troika officials slowly verify compliance with outdated conditions, impossible for a poor country to satisfy; the continued prohibition by the ECB of the Greek government raising finance through the issue of short term Treasury bills, indeed the imposition of ceilings on banks’ holdings of such bills, under the pretext that in Greek circumstances this would amount to funding the government deficit directly (a peculiar dysfunction of the ECB, seeing that the independent Bank of England and the independent Central Bank of Japan are allowed to fund government deficits all the time). 

At the end of March the Greek government is facing a bill of €1.7bn for wages and pensions; on 9 April the IMF is owed a loan repayment of €450mn, and in mid-April two Treasury bills for a total of €2.4bn also are due for repayment.  

Since the elections of 25 January Greek corporations and households have cut their tax payments drastically; a government running a primary surplus, even at the reduced rate of 1.5% of GDP, should always be able to finance current public expenditure but now the position is unclear.  The Greek government has been particularly skilled at mobilizing cash belonging to the National Health Service and state-owned corporations to  keep the government afloat. But cash withdrawals from the banks have been accelerating since the new year, both before and after the elections.  According to Barclays on Wednesday 18 March withdrawals reached a record €300mn per day, at which rate they regarded a block on deposits as unavoidable (not least because of this kind of malicious rumour).  The Greek government has admitted that without fresh funds they will not be able to meet all payments due in April: we should believe them.  Failure to repay the IMF loan instalment would not have immediate adverse implications, but would involve the loss of all IMF credits.  Failure to repay the €2.4bn Treasury bills would trigger-off cross-default clauses in other loans and precipitate a deeper crisis, including the likely loss of ECB Emergency Liquidity Assistance.  At that point a run on the banks, stricter limits on bank withdrawals, capital controls and actual default would become self-fulfilling prophecies.  In order to avoid the de-monetisation of the economy and its vast contractionary implications the government would be forced to issue a euro substitute, i.e. a new currency parallel to the Euro.

The transition to the new currency presumes that the new banknotes and coins can be produced quickly or, better, well in advance in complete secrecy. Normally this would take about six months; it has been suggested that the new currency could be introduced by stamping old euro notes as drachmas, but this would be a silly waste of good money.However a cash shortage could be initially tackled by means of the issue of small denomination Treasury notes, or by the issue of bank cheques like those that were introduced in Italy in the 1980s to deal with a shortage of coinage. At least initially, and indeed for some time, the euro and the new currency would circulate in parallel, but as long as the rate of exchange between the two was market determined this should not create problems other than some confusion and uncertainty.

It might be safest to turn our deposits into bricks and mortar, withdraw as much cash as we can as fast as we can while we still can, and hide it under the mattress to avoid negative interest rates. Actually, si vis pacem para pacem, as Pope Francis might have said, and if you want to keep the Euro get on with completing a banking Union, promote fiscal and political integration; above all Growth and Stability suicide Pact must be imaginatively re-interpreted and accompanied by a serious, large scale, European public investment effort. Together with the felicitous large reduction in oil price, overdue but welcome Quantitative Easing by the ECB and substantial euro de-valuation, this might still do the trick without the drama and trauma of Eurozone and European Union dis-integration.


Muppet said...

Would Greece actually be allowed to issue a parallel currency?

D. Mario Nuti said...

Once Greece has lost access to aid and ECB Emergency Liquidity Assistance they would have nothing to lose, they could not be fined or threatened with anything. No way a parallel currency could be stopped. And that would be equivalent to a de facto exit.

Franz said...

Would the Eurozone become more manageable if the Germans and the Nordic countries left and set up their own strong euro, while the Southern countries kept but made it weaker?

Goldilocks said...

And just how would you propose to "imaginatively re-interpret" the suicidal Growth and Stability Pact? With a bit of creative accounting??

D. Mario Nuti said...

It has been suggested - among others by George Soros - that the Germans should leave rather than the Southern members.

This of course would leade to rapid appreciation of the new DM, just as it happened to the Swiss Frank once the Swiss Central Bank abandoned the peg to the euro.

German net exports and therefore income and employment would suffer. Germany has no incentive to do this. Much better to be in a position to enjoy superior competitiveness and bully the rest of Europe.

D. Mario Nuti said...

How to re-interpret imaginatively the GSP? There are genuine and not simply cosmetic possible improvements,

For instance:

- remove public investments from the calculation of government deficit;

-treat government borrowing for the purpose of paying off arrears owed to government suppliers as a change of creditor and not as an increase in debt;

- calculate potential income like the OECD does.

These measures alone would promote Eurozone growth as if by magic.

Alberto Chilosi said...

"the transition to the new currency presumes that the new banknotes and coins can be produced quickly or, better, well in advance in complete secrecy."
There is another way, following Milosevic example. Since the end of 1990 Milosevic, reacting to the "austerity" policy of the Markovic federal government instructed the Bank of Serbia to create dinars without the authorization of the Yugoslav Federation Central Bank. This led to the failure of Markovic stabilization policy and to the dissolution of Yugoslavia. Eventually the rate of inflation, which had reached 60% before Markovic, reached with Milosevic astronomical levels. What Tsipras could do is simply to let the Central Bank of Greece create euro balances and print autonomously Euros (as ìt does presently on behalf of the ECB).

D. Mario Nuti said...

Sure, the Central Bank of Greece could create euro balances, but its ability to print euro banknotes is strictly limited.

It is true that only 8% of banknotes are printed by the ECB, while the remaining 92% are printed by the national Central Banks of Eurozone member states, but the stock and circulation of banknotes are closely monitored and controlled by the ECB.

1) The total amount of banknotes to be printed at any time is authorized by the ECB;

2) Each national Central Bank can only print a share of the 92% of euro banknotes authorized by the ECB proportional to its ECB shareholding;

3) Each NCB is responsible for the production of certain denominations assigned by the ECB; for instance in 2014 Greece only was enabled to print (directly or through a specialized printer, national or foreign) €5 and €10 banknotes, identified with the letter Y in their serial number.

Therefore the the Central Bank of Greece could not print euro banknotes at will.

Nico said...

You say that Italy is not supporting Greece out of "perceived self-interest", but surely Italy can only gain from Troika generosity towards Greece and the promotion of European policies of investment and growth?

D. Mario Nuti said...

Yes, Nico, but evidently Italy's exposure to €40bn Greek bonds going toxic is regarded by Matteo Renzi - probably wrongly, and in spite of his rhetoric - as a more tangible loss from Grexit than the uncertain indirect advantages of an unlikely European policy change towards investment and growth.

Robot said...

If Greece did issue a parallel currency, would this decision be difficult to reverse?

D. Mario Nuti said...

Not at all, the measure could be easily reversed. Preferably - if the parallel currency was successful in improving competitiveness and reduce debt - after it had recovered the parity with the euro. Or at any time at the market rate of exchange prevailing after the announcement of imminent re-conversion back to the euro.

Anonymous said...

Almost half a billion due for repayment by Greece to the IMF on 9 April. And Tsipras meeting Putin in Moscow on 8 April. Will good old uncle Vladimir sign him a fat cheque?

Zecca said...

So the Greek Central Bank is only allowed to print €5 and €10 notes. Perhaps they should be allowed only to mint 1 and 2 cents coins.

D. Mario Nuti said...

Not the best time to ask Russia for financial support, in view of the low oil price, Ukrainian sanctions, rouble devaluation and the large fall in Gosbank reserves. But there is still a lot of fat, and half a billion is nothing among friends.

Fred said...

You are right, “Si vis pacem, para pacem” does sound like something Pope Francis might have said, but as a matter of fact the dictum was coined by Barthélemy Prosper Enfantin, described as an early French socialist and one of the founders of Saint-Simonianism, as early as 2 April 1841, with reference to the war with Algeria.

D. Mario Nuti said...

Thanks. Amazing. Nihil Novi sub sole.

D. Mario Nuti said...

It has been claimed that "Berlin actually encouraged the Papandreou regime in 2009 to exaggerate the size of Greece’s debt hole", see

Is that a credible story?

Jodi said...

It is certainly credible, Schauble and Papandreu are capable of anything. But we will never know whether it the story is true.

Zig said...

So, what is going to happen next? Has Grexit been averted or is it still in the cards?

D. Mario Nuti said...

Anything could happen. Greece has paid the $450mn or so that it owed the IMF on 9 April, much to everybody's relief, but there still are €2.4bn worth of Treasury Bonds also falling due shortly. Plus €203mn on 1 May and €770mn on 12 May and €1.6bn in June all to the IMF.

It all impinges on whether the Troika will decide that Greece has undertaken or is credibly committed to the structural reforms (pension cuts, labour dismissals and privatisations) on which the release of the residual €7.2bn bail-out funds were conditional.

Without access to these €7.2bn Greece is likely to default on its payments to the IMF. This does not involve exit automatically but in practice it would, through the cessation of access to ECB Emergency Liquidity Assistance, Bank runs, likely issue of a substitute currency etc.

Only time will tell. We will know soon enough.

D. Mario Nuti said...

Two pieces of bad news in today’s FT raise the probability of Greece defaulting in May.

Apparently Greek officials have approached informally the IMF proposing to delay the repayment of loans due in May and June (see previous comment) but were told that no rescheduling was possible; indeed they were persuaded not to make that request officially, presumably to avoid an open refusal.

At the same time Germany’s finance minister Wolfgang Schäuble is reported to have virtually ruled out, in an interview, that at the Eurogroup meeting in Riga on 24 April a deal might release bailout funds to Athens. "You can't spend hundreds of billions... in a bottle without a bottom."

However Die Zeit reports that Ms Merkel now might support emergency measures that would give Greece continued access to ECB Emergency Financial Assistance even in case of default. It is diffisult to believe that ECB rules can be made so flexible, even by Ms M.

D. Mario Nuti said...

The writing is on the wall:
“The European Central Bank is studying measures to rein in Emergency Liquidity Assistance to Greek banks, as resistance to further aiding the country’s stricken lenders grows in the Governing Council” (BloombergBusiness 21/04/2015).

D. Mario Nuti said...

"Bleak in Greece. Athens’ chances of striking a deal to access a much-needed EUR7.2bn in rescue aid looked even worse on Sunday after Alexis Tsipras, prime minister, accused bailout monitors of making "absurd" demands and seeking to impose "harsh punishment" on Athens." (FT, 1 June)