A summary of my January 2012 proposal for the future of the Euro

           The Euro area needs  economies which have converged sufficiently to be managed together with sustainable  budget deficits and debt refinancing requirements.


           The Euro founders  set out sensible tests to ensure only countries equipped to deal with Euro  discipline joined.  In the initial enthusiasm  it was decided  to allow a number of countries to join which were far from converging.  In some cases the discipline of the zone has brought convergence, in other cases  countries have needed  IMF programmes.


           The task is to carry out the least number of changes necessary to create a sustainable remaining Euro area capable of growth and greater prosperity, whilst freeing the exit countries sufficiently so they too can grow again. There are four  main economic strains: big  balance of payments imbalances between countries, high unemployment in some uncompetitive countries , banking weakness, and state debt financing problems.


           Some countries will over time become more competitive through zone  discipline.  They have to raise productivity,  and set real wages at appropriate levels. Some of these adjustments can prove painful, if wages  have to fall. Others with more urgent problems may need to leave the Euro to  adjust their economies more fundamentally. Devaluation is part of the answer for an extreme case like Greece,  providing an immediate  adjustment to competitiveness. It  cheapens  exports and makes imports dearer, adjusting the trade deficit.


          Some countries with debt problems will over time be able to cut their deficits by cutting spending, or by growing their   tax revenue more rapidly.  Countries with large inherited debts will need to repay some debt when possible. Others simply have too large a  debt and  deficit to make longer term adjustment a sufficient answer. Greece again is the extreme case. Greece  is seeking a voluntary arrangement with private sector creditors to cut the debts. Devaluation following exit from the Euro could help.


The optimum monetary reconfiguration


The early  exit of Greece from the Euro zone  is recommended, as the least change needed.


 Portugal and possibly  Ireland should also be invited to leave the zone.  Neither can finance themselves in the markets in the usual way, despite austerity packages and substantial new borrowings from the EU and IMF. Early exit, devaluation, and domestic growth policies including monetary accommodation to foster the private sector would help, and would reduce the strains on the zone.


Italy’s main problem is the overhang of past debt. This may be manageable. Italy can meet the deficit and inflation requirements. The country is rightly  putting  in place more productivity and  cost reduction  policies to improve competitiveness.


Spain has serious problems with banks and the past property bubble. She would probably recover more quickly with devaluation. However, there is considerable support in Spain and the  EU to keep Spain in the system. She can still borrow in the normal way in the markets to pay the bills, and is keen to pursue fiscal orthodoxy .


Italy and Spain will be  supported in  the zone. There is no power to force their exit. The question of a country leaving the Euro should automatically arise if and when the country needs to seek financial assistance, when the EU does have negotiating power to request an exit. These proposals do not require Treaty revision,  avoiding the delays and political difficulties that poses.



Implications for sovereign debt, private savings and domestic mortgages.


It is recommended that an exit country changes all contracts, assets and liabilities into its new currency for domestic users  under its jurisdiction.

 Devaluation  helps the borrower and harms the lender. As the exit countries are too heavily in debt, this natural bias  helps recreate equilibrium.


Implications for international contracts denominated in Euros.


It is further proposed that the EU legislates for compulsory conversion of all assets, liabilities,   and contracts for all  EU citizens and resident companies to the new currencies.

 Foreign owners and contracting parties  outside the EU should have the right to negotiate their future currency  between Euro and any new  currency, avoiding jurisdictional clashes.



Effects on the stability of the banking system


The current banking system is unstable. In peripheral countries like Ireland and Greece the banks have too much debt. Banks throughout the zone have lost money on holding bonds in the weaker countries, and may also have lost money in the property crashes in peripheral countries. The system is currently heavily dependent on ECB support through its large  loan facilities


The exit countries  should  establish their own Central banking regime immediately. They should  reassure during the transitional period, promising to stand behind their commercial banks, and making plenty of liquidity available.

The ECB would need to continue its generous policy towards the remaining banks in the system, and to the exit countries whilst they establish their own arrangements.


Overall stability would be improved. Markets would have a clearer idea of true values and losses, which could help confidence . Responsibility for the worst cases would pass to new national institutions in the exit countries, enabling the ECB to concentrate on the large cases of Italy and Spain.


Approaches to transition


The paper sets out a timetable, and provides advice on the legal, economic and political steps  for  a successful   early exit of some countries from the zone. Much has to be done right at the beginning.  Preparations need to be fast, thorough and secret , so  when the news is announced all the key matters are in place for a smooth transition. Fortunately there  are many precedents for this work. The author has traced 87 successful cases of exits from single currencies or  zones since 1945.


Institutional implications


It is recommended that the exit countries become EU countries with an Article 139 derogation from immediate membership of the Euro. They will revert to candidate status. This reduces the legal and institutional complexities. They need to provide nationally  for full powers for their enhanced Central Banks to resume their old  roles. The rest of the Eurozone continues under its current legal framework, using the present   institutions.


John Redwood


             Distinguished fellow of All Souls College Oxford . 

 Lectured on the Euro  at Oxford,  Cambridge, Middlesex Business School  and other universities.


¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† He wrote one of the two Penguin books on the Euro.¬† His ¬†‚ÄúThird Way Which way?‚ÄĚ set out a new way of analysing public and private sector activities. His ¬†‚ÄúAfter the Credit Crunch ‚Äú ¬†¬†and¬† ‚ÄúSurviving the Credit Crunch‚Ä̬† provide commentary on the recent economic and banking crises.


               He has chaired international  industrial businesses, and  been  a Director of a bank and of various financial sector companies.


  1. lifelogic
    April 10, 2012

    What a wonderful mess the EU has, intentionally, created to grab more and more power to the centre much encouraged by Libdems, Labour and over half the Tories.

    It is good to see shareholders finally trying to do something on directors pay at Barclay’s. Company law needs to give far more real power to shareholders. Shareholders also need to be able to fire, without any substantial pay off, directors and employees as needed for the good of the company.

    1. Denis Cooper
      April 10, 2012

      No doubt most advocates of the euro project recognised that it necessarily implied more power for the EU, but I don’t think that many of them actually intended that it would lead to a potentially catastrophic mess which would permit further power grabs. That would have been, and remains, an extremely risky strategy.

      There was a reckless assumption that simply sharing the same currency would lead to further convergence between the different economies, automatically ensuring that it would become increasingly stable as time passed. In fact there were soon worrying signs that the economies were starting to diverge rather than converge, as observed by the europhile FT not long after the euro was launched.

      For those who had thought that might happen, but who believed in “ever closer union” and so still wanted the euro, the fallback position was that the problems would create opportunities for the EU to grab more power.

      Having said that I repeat my reference to the recent statement from the German embassy:


      “A milestone in European integration”

      “On 29 March, Members of the German Bundestag held a first reading to consider the bills on the European Stability Mechanism (ESM) and the European fiscal compact. In his contribution, Foreign Minister Westerwelle identified ‚Äúmore Europe‚ÄĚ as the answer to the crisis and pledged that the Government was seeking to achieve budgetary discipline and growth in Europe. What the Bundestag was deliberating, he said, was a ‚Äúmilestone on the road to greater European integration‚ÄĚ.”

      All the more reason for the UK Parliament to prevent the UK government ratifying the EU treaty change to provide a legal base in the EU treaties for Germany and the other eurozone states to have their ESM treaty, which Parliament could do by refusing to pass the Bill to approve it.

      1. Denis Cooper
        April 10, 2012

        JR, it is only fair that people in this country should know what the German Foreign Minister has said according to the German embassy in London.

    2. uanime5
      April 10, 2012

      Shareholders already have the powers to fire directors and employees. They can’t use these powers effectively because there are usually more shareholders than employees working in the company.

      Until there’s a way for shareholders to unite and have a single organisation use the combined voting power of these shares to force companies to change shareholders will remain powerless. I believe they have a system like this in Germany where people can register their shares with a bank and the bank votes on behalf of all their shareholders. Unsure if this will work in the UK.

  2. Paul Danon
    April 10, 2012

    Thank you for all the material on this. Although it’s a strategy for benign euro-exit and national recovery for e.g. Greece, it involves much intervention. What, I wonder, would be the market-based solution? What if nations, banks and people were left to find their own level – a bit like Iceland? How could we get something robust to emerge from this d√©bacle? What would Hayek do?

    Reply: As we start from a centrally managed system there does need to be a lot of political intervention to sort it out. I am proposing returning to more competing national currencies. Radicals might say privatise money, allowing private sector commercial bank money to replace the Euro in Greece. Given the state of some Euro area banks, and the need for speed in doing something, I cannot see this would be a good time to launch something so radical.

  3. Acorn
    April 10, 2012

    “It is further proposed that the EU legislates for compulsory conversion of all assets, liabilities, and contracts for all EU citizens and resident companies to the new currencies.” [JR]

    How and when will the “new Greek currency” exchange rate be established; with the Euro and say with the Pound Sterling for contractual purposes at the least? If a UK resident company has wholly Greek assets (holiday villas say) when would that company be deemed to be insolvent, as the new currency devalues, and the company has none Greek currency debt obligations?

    Zimbabwe, is the reverse situation to Greece. Mass money printing devalued the sovereign currency to nothing. Zim’ now uses the US dollar and the SA rand for currency. The collapse of the Zim dollar means there is no domestic capital to invest in anything. They need train loads of FDI (foreign direct investment). I think the old Zim dollars are only used for tax payments now, to extract them from the banking system. Your plan sounds good for Greek and EU politicians and bureaucrats; but, I am not sure that it is good for private sector non-financial institutions. Particularly if you want to invest in Greek real assets, to dilute your losses.

  4. stred
    April 10, 2012

    Brilliant Effort. Hopefully, the EU will pay you for this when adopted.

  5. Denis Cooper
    April 10, 2012

    I wonder whether it would be necessary for the (say) Greek government to interpose itself between foreign creditors and their private debtors within Greek jurisdiction.

    Meaning that the Greek parliament would legislate so that all private persons and companies and other entities in Greece which owed money to external creditors would instead owe it to the Greek government, and they would pay in new drachma, while the Greek government would owe the original money to the external creditors in euros and other foreign currencies.

    It seems to me that might be the only way that the necessary default on the private external debts could be managed in an orderly fashion, by making them all debts of the Greek government which then would negotiate the terms of its default in the same way that it negotiated default terms with its bondholders.

  6. Antisthenes
    April 10, 2012

    Very neat and tidy and one has to wonder why the EU elite are not proceeding along those lines. To me your plan shows common sense and as bad as the elite are I am sure they have considered plans like yours and obviously have to date rejected them. I suggest the reason are that they fear that in practice things would not have the outcomes that you believe. Also I believe they see the situation as an opportunity to further the EU project and that decoupling may put the EU project back many years or even destroy it all together.

  7. uanime5
    April 10, 2012

    It may be possible to use regulations or a treaty to determine what will happen to assets after a country leaves the Euro. This will allow private companies to make an informed decision about whether or not they want to invest in a country that is like to replace stable currency with one that will rapidly devalue.

  8. David Saunders
    April 10, 2012

    The best way to stop so called “morally repugnant” (but perfectly legal) tax avoidance is for the tax system to be reformed and simplified and for taxation to be lower so that tax avoidance is much less worthwhile.

  9. Bert Young
    April 10, 2012

    Of course Greece must exit the Euro . It cannot compete successfully within its system now any more than they could before they joined . Attempting to struggle to meet the stringent terms required is beyond all reasonable resources and the intervention intended to patch things up must stop . JR’s format appears to be a practical method of allowing a withdrawal in a disciplined and structured manner ,so, unless something else emerges from the Eurocrats equally sensible and, to the outside world , acceptable , push hard for its adoption asap . Ireland and Portugal are , basically , in the same boat and have to face-up to the same regime . I for one am fed up with all the political shillyshallowing and want to see a quick resolution .

  10. Simon Smith
    April 10, 2012

    Just get the Germans to leave the Euro and the new currency will be worth what it should be and a lot fewer problems for the PIGS.

  11. Freeborn John
    April 10, 2012

    “It is further proposed that the EU legislates for compulsory conversion of all assets, liabilities, ¬† and contracts for all ¬†EU citizens and resident companies to the new currencies.”

    This would imply that any UK citizen with deposits in a bank headquartered in a country exiting the eurozone (e.g. Santander, etc.) would see their savings forcibly devalued. If that were to become EU legislation then it should trigger a run on such banks in the UK. One might say that UK deposit insurance might recompense British savers in such circumstances but why should UK taxpayers be forced to make good losses which are then so eminently foreseeable that no sane saver would risk their money if the taxpayer guarantee were not there? Far better to replace ‘EU citizens’ with ‘citizens of a eurozone state’ to make clear that UK savers cannot be fleeced in this way and that eurozone banks should repay sterling deposits in full.

  12. sm
    April 10, 2012

    How does all the LTRO financing get repaid or will just be rolled over? Whoose taxpayers will be left holding the bag?

  13. lojolondon
    April 10, 2012

    The EU is resisting, because when Greece defaults and moves from the Euro to the Drachma and we all book our holidays there, the economy will boom. Greece will have no debt and all the money will be to spend, not paying interest. After 2 years, the other countries will learn what they have failed to learn from the UK and from Iceland, that having your own currency pays, big time.
    Then most countries will want to leave the Euro. Great news for all the people of Europe, except Germany who have exports based on the weak Euro, and France who claim back more on CAP than they submit each year.

    But very bad for those on an EU salary.

    So it will not happen, until there is armageddon in Greece.

    1. sjb
      April 11, 2012

      With regard to funding by Member State, let me direct you to the following:
      Funds by Member State

      I checked all of the four possible years (2007-2010) and every time it reported France paid more into the EU than they received from the EU. Perhaps you would be kind enough to provide your source.

  14. James Reade
    April 13, 2012

    A set of proposals which simply will not work – if the intention is a eurozone that remains functioning, that is (and I doubt that’s your real intention John).

    The eurozone needs countries willing to allow structural change to happen, willing to allow prices (most notably real wages) to change in response to demand and supply rather than seeking refuge in protectionism.

    Once you expel members, or allow them to leave, as I’ve said repeatedly here, you end the eurozone. It no longer becomes what it was set up to be, an irrevocable fixed exchange rate system. Once you allow countries to leave, speculators go to work because it’s just like all other rules politicians have tried over the years to bind themselves (ERM, anyone?) – not credible any more.

    However, as said, I think this is what you want anyway John, isn’t it?

    Bit like your deception regarding tax openness really? I’m sure you have some response to the Liberal Conspiracy article from yesterday?

    Reply: Other currency unions have shed memebrs whilst the underlying currency has continued – as with the sterling zone and the departure of Ireland. What is your other point from yesterday?

    1. James Reade
      April 15, 2012

      Ireland leaving the poundzone is very different since there was a distinct political movement taking place that drove that. Can you really argue that you don’t think that once one country is allowed to leave, then the moment another hits trouble, speculation will drive that one to leave too? Once one leaves, it’s nothing more than the ERM was, and we know how that failed…

      (Also raises issues about my tax and salary which are based on false reports in some other blog-ed)

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