Shawkat Hammoudeh
My correspondences with my European co-authors during the last two months have concentrated on whether Greece, Portugal and Spain should stay within the Eurozone or overthrow the euro regime for good. My European correspondents have underscored the major change that has taken place in Europeans’ preferences toward shifting away from the euro to the national currency. They have witnessed the benefits in the Eurozone moving away from their national economies toward the German economy. They affirm that pipeline that channels the benefits to Germany is the euro. Therefore, hostility toward the euro is rising in the southern European economies. Many now wish to exit the Eurozone.
In my correspondences, I heighted that the withdrawal from the Eurozone can have catastrophic consequences and that certain rules should be followed to minimize those consequences. The following rules must be taken seriously before the exit takes place:
1. If there will be an exit, it must be very secretive and should happen very quickly. Any disclosure, leak or lingering will lead to the exodus of enormous euro-denominated funds to a euro territory that would cause bankruptcies, recession and maybe a depression in the exiting country.
2. Just to account for a possible leak or insight information happening before the withdrawal, the exiting country should temporarily stop all money transfers with the rest of the world, particularly with those fellow countries in the Eurozone when it is ready to exit. This may require shutting off all electronic communications, including funds wires, Internet, fax, etc. with the outside world for few days.
3. The exiting country should find a quick way to transform the euro currency into a national currency such as the drachma to keep its function as a medium of change working during the exiting period. History tells us of examples where the splitting country in a currency union in the 19th century stamped the common currency into a national currency temporarily before it was replaced by a true national currency.
Following those rules will not keep the exiting country immune to the grave consequences, but it should help in the long and hard transformation out of the currency union. The hardest task the exiting country should deal with is the denomination and valuation of the national debt that includes retail, commercial and sovereign loans. If the agreement stipulates that the debt must be denominated in the national currency, then the exiting country’s risk exposure is reduced and the risk exposure is shared with the lender. However, if the debt is stipulated to be in the union currency, whether signed in the exiting country or another country, both the executive and legislative branches must deal with it simultaneously and discretely. The legislative body, in coordination with the executive branch, should have parallel sessions during the euro stoppage period to rectify what the executive branch sealed according to the rules above.
Failure to follow those rules will mean runs on banks, bankruptcies and recessions in the very short run. The sovereign debt burden (as a percentage of gross domestic product) will jump sharply in the medium term. There will be internal and international devaluations that will eventually lead to inflation. At best, the exiting country would have to go through a period of severe stagflation at best over the years. No one knows how long this period will last, but it should take several years, maybe as long as one to 10 years. Having said all that, one should not end without underscoring the dangerous contagion that is likely to follow the withdrawal, which should also carry a second-round negative effect on the exiting country.
Shawkat Hammoudeh is a professor of economics. He can be reached at [email protected].