In this essay we evaluate the alleged costs of a euro exit and propose practical steps to make a withdrawal from the euro as smooth as possible.
The costs of remaining within the euro are very high. These costs do not only include the costs of the open bailouts and guarantees for the rescue funds. The euro is a misconstruction as several independent governments can finance their deficits through one (central) banking system. The incentive is to run higher deficits than other states of the EMU. The setup of the Eurosystem made interest rates converge and enabled monetary redistribution. Due to its incentives there is a tendency for price inflation.
To save the euro the ECB will have to be highly inflationary in the future. The ECB will have to keep accepting or buying governments bonds and finance the rescue funds. Within the EMU the incentives to reduce deficit spending are diminished. There is a general tendency for the size of government to increase due to this inflationary deficit spending. Most likely, only a centralization of some sort (fiscal union) will be able to save the euro at this point with its current members. The growing size of government and the centralization imply a loss for individual liberty for citizens of governments that remain within the euro. Lastly, the redistribution may cause conflicts between nations and disturb the harmonious cooperation in Europe.
The problems of a euro exit have been largely exaggerated. Introduction costs, wage inflation, trade losses, political costs, legal problems, procedural costs, banking crisis, costs of disentangling of the ECB, pose important but no insurmountable problems. With accompanying measures and careful negotiation these problems are all solvable.
We found three ways to exit.
First, redenomination of all contracts and deposits into a new national currency. Coins and notes bearing the national symbol are exchanged gradually into the new currency preferably at a 1:1 exchange rate. In order to prevent disturbing flows of capital a “provisional” redenomination allowing for democratic discussion is found as the most elegant way.
Second, issue of a parallel national currency. This national currency may be backed by government or central bank assets preferably gold and would compete with the euro.
Third, currency competition. All legal tender laws are abolished. Gradually, citizens will start using more stable currencies and possibly adopt commodity based means of payment.
It is essential to accompany an exit from the euro with supporting reforms to alleviate transition costs. The sovereign debt and euro crisis is foremost a crisis of the state that has grown to a dimension that threatens the stability of the euro currency. Accompanying measures must roll back the state. In order to introduce a new currency with success it is essential that the new currency is expected to be less inflationary than the euro.
As a banking reform will be necessary in any case, an exit from the euro should be used to thoroughly reform the banking and monetary system putting them finally on a sound basis. Moreover, the public deficits should be eliminated, old public debt restructured, public assets privatized, markets deregulated and made flexible, and taxes lowered.
I recently presented these ideas to the European Parliament in a conference sponsored by the EFD group (starting from 41:20):