The Wolfson Prize: How to end the Euro

[Sheilbh]

The prize was announced because there's a lot of talk of Euro break-up.  It seems that the conditions people attach that are necessary for the Euro to survive the next few years are, frankly, often impossible and mutually incompatible.  But this prize is about the break up and has produced interesting entries I think, because most talk of this is rather vague.  Main story from the BBC, but I've interjected the prize's descriptions:

Five ways the eurozone could break up

The Wolfson Prize offers £250,000 to the economist who comes up with the best plan to manage a potential break-up of the eurozone. The five ideas in the running are summarised here.

The conundrum posed is this: "If member states leave the Economic and Monetary Union, what is the best way for the economic process to be managed to provide the soundest foundation for the future growth and prosperity of the current membership?"

Lord Wolfson, whose family charity puts up the prize money, has said there is a serious need for a solution to any euro break-up. Here are the short-listed entries:

1. Greece - or another country - could go

The most realistic scenario for euro break-up is that Greece, or one or more of the weaker peripheral countries, will leave the eurozone, introduce a new currency which then falls sharply, and default on a large part of their government debt.

Preparations for exit must be made in secret and acted on straightaway. Just before departure, some form of capital controls will be essential, including temporary closure of banks and ATMs. With no time to print new notes, euro notes and coins should continue to be used for small transactions. The new currency should be introduced at a one-for-one rate with the euro. But it will soon depreciate by something like 30-50% giving a boost to Greece's international competitiveness.

The government should redenominate its debt in the new national currency and make clear its intention to renegotiate the terms of this debt. They must announce robust measures to keep inflation in check but, with them, markets may well lend to the exiting country again the medium term. Importantly, the exiting country has an opportunity to break free from a crippling debt strait jacket.

That's by Mark Pragnell, Roger Bootle and others at Capital Economics.  The Prize described their entry thus:

The essay from Roger Bootle and Capital Economics provides a practical guide to the issues around exiting the euro.  Their central focus is how to achieve a fall in real wages and prices with the minimum practical disruption. This essay proposes that government debt and consumer debt be redenominated into euros deploying the 'lex monetae' principle – in other words, that each country determines the currency applicable under its laws.

2. Pain sharp but short-lived

Many economists expect catastrophic consequences if any country exits the euro.

However, during the past century, 69 countries have departed from currencies with little downward economic volatility.

The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real underlying problem in Europe is that peripheral countries have external debt levels that are higher than most previous emerging market crises, and they face severe misalignments in wages and prices with their neighbours in the core. Europe has the characteristics of a classic emerging markets balance of payments crisis writ large. As such, the problem is not the mechanics of exit, but of managing a severe and necessary adjustment.

The adjustment can come quickly via exiting the euro and devaluing, or slowly via a fall in real wages and prices.

Exiting from the euro and devaluing would be very painful, but the pain would be short and sharp.

Departing would accelerate insolvencies, but would provide a powerful policy tool to restore competitiveness via flexible exchange rates. Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable.

The European periphery could then grow again quickly with lower debt levels and more competitive exchange rates, much like countries that left the Gold Standard in the 1930s (Britain and Japan 1931, US 1934, France 1936) and many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, Argentina 2002, Iceland 2008).

Jonathan Tepper of Variant Perception.  The prize's description:

Jonathan Tepper contends that currency exits and devaluations are often predicted to lead to "Armageddon" but rarely do. The paper argues that the real issues are not created by the exit process per se, but by the needs that motivate the exit — the need for Eurozone periphery countries to default and devalue.

3. All return to national currencies

Germany should commission a top-secret task force, to prepare a plan for use only should one country be imminently leaving the eurozone. The plan would call for an emergency meeting of the leaders of the 17 eurozone states, and the German chancellor put to them the proposition that they collectively, and immediately, abandon the euro, reverting to their national currencies at euro entry rates.

The ECB would be abolished and its functions returned to the national central banks. All bank accounts, assets, liabilities and obligations in each member state would be immediately redenominated into national currencies. Assets, liabilities and derivative contracts that are not identifiable as domiciled in a specific state would be redenominated into a run-off ECU - a basket of the new currencies weighted by ECB shareholding.

All member states would agree to extend unlimited liquidity to the banks domiciled in their states, and most would require re-capitalisation. Euro notes and coins would all be redenominated into the currency of their issuing national central bank (euro notes have serial number prefix letters identifying the issuer). National notes would be printed as soon as possible. Markets would re-open after enforced bank holidays, and the new drachma would fall, say, 60% below its official euro conversion rate; the new deutschmark would rise, say, 20% above its official conversion rate.

This would allow the southern states to get back to work, and curb Germany's chronic trade surplus with the eurozone. This route would be cataclysmic, but would finally end the crisis, and lay foundations for a new Europe. The German chancellor would explain that should they not all agree to Germany's request, then Germany would implement a separate plan to leave the euro itself.

From Neil Record, of Record Currency Management, described here:

Neil Record argues that if any country leaves the euro, the entire euro must be dissolved. He writes that the moment one country leaves the euro, the view that the euro is 'permanent' becomes untenable, giving markets the ammunition to undermine structural weaknesses elsewhere.  The essay's focus is administrative, emphasising secrecy for as long as possible and setting out a detailed week-by-week timetable.

4. How to redenominate currencies

A break-up of the eurozone implies a need to redenominate contracts from euro into new currencies. This is relevant for bonds, loans, deposits and other financial instruments.

This process is complicated by various legal constraints. Different financial instruments are governed by different laws, and many euro denominated instruments are governed by foreign laws, especially English laws.

Eurozone governments cannot change laws of foreign countries and they cannot easily redenominate foreign law assets. Since there are tens of trillions of euro-denominated contracts in existence under foreign law this is a very large potential problem.

Our plan stresses the importance of facilitating an orderly currency redenomination process in all break-up scenarios. This includes the need for an ECU-2 currency basket to settle euro claims in a full-blown break-up, where the euro ceases to exist. The ECU-2 would constitute a bridge between the euro (which no longer exists in a full blown break-up) and the new national currencies. The ECU-2 concept would thereby help avoid arbitrary currency conversions and prolonged legal battles about redenomination. In the absence of an efficient process for redenomination, a full-blown break-up of the eurozone is likely to be devastatingly disruptive and could see a complete freeze of the global financial system.

By Jens Nordvig and Nick Firoozye of Nomura Securities:

Jens Nordvig and Nick Firoozye argue convincingly that the treatment of foreign law debt contracts is important because there is around €10 trillion outstanding. Their essay proposes that debt contracts falling under national / local law should be redenominated into a new currency.  Debt contracts falling under foreign law should be redenominated into a second European Currency Unit (ECU).

5. Split the eurozone in two to stop currency flight

My approach is designed to allow an orderly transition of the eurozone to two or more regions, and prevent the speculative capital flow, that could force a country out of the eurozone.

These new regions would have their own central bank, monetary policy, and currency unit. All euros would get treated equally and get exchanged for a basket of the new currencies at an agreed and fixed exchange ratio - the paper describes how this ratio gets set. So everyone would receive a basket of the new currencies, and it would be up to them to decide what currencies to exchange them to. The settlement value of existing euro-denominated contracts and debt could be determined by the exchange ratio and the relative value of the new currencies.

Post-separation, competitiveness could be restored by the exiting country or countries managing a gradual devaluation, using higher nominal interest rates and inflation. Higher interest rates prevent a sudden currency collapse and stops currency flight. In addition, any renegotiation of, or default on, debt could be managed quite separately. And, unlike with a crash exit, savers in the exiting countries are not penalised and speculators are not rewarded and the process can allow time for migration to the new currency regimes. Because it reduces the risk of speculative capital flows, the "Newney" approach - New Euro-White (New and New Euro-Yolk (Ney) - could also support the eurozone remaining together.

By Cathy Dobbs, a private investor:

In an original and elegant solution, Catherine Dobbs proposes that the euro disappears, with all holders of euros having their euro claims replaced by claims on the new currencies, according to a set proportion.  The key objective is to disincentivise capital flight (and hence bank runs and financial and social crisis), whilst being fair to all holders of euros.

I think the final entries have until tonight to refine their essays based on the judge's comments when drawing up the short-list.  The winner will be announced in July.  Until then the essays entered and some video are here:
http://www.policyexchange.org.uk/component/zoo/item/wolfson-economics-prize

A 10 year old Dutch boy received €100 for his entry here.  Better than anything I could do:
http://policyexchange.org.uk/images/WolfsonPrize/wep%20special%20entry%20-%20jurre%20hermans.pdf

[alfred russel]

I didn't read them all, but #1 could be cut and pasted from any number of op eds out there. We could come up with that for £250,000. Hopefully there is a lot more to it than that.

#4 hits what I think is the biggest problem spot is. I'm not going to read the paper, but if I was going to read one if them, that would be it. 

[Admiral Yi]

The Dutch kid's entry is precious.

[alfred russel]

The Dutch kid's entry is precious.

When I was in the 8th grade I won an essay contest on how to fix what was wrong with the country. Got it printed in the newspaper and everything. Thankfully, this was well before the internet, because my solution was basically to be more xenophobic.

[Admiral Yi]

Not as precious.

[PDH]

I once won a contest on how to stop people smoking on the Oakland, Ca bus line (I was 7 at the time) with my entry "Pour a buket of sand on thier head."

I won a W.C. Fields book.