Economic Sophisms

I think the most reasonable way to take apart the euro is to make it redeemable into a composite of national currencies. (I am sure someone else as thought of this, but I haven’t seen it yet.) You could think of it as turning each euro into a currency index ETF, with the index weightings given by a country’s share of 2011q1 Eurozone GDP. This would provide a way of ensuring that the pain is spread proportionally and take away the incentive to move deposits into Germany.

If you had a euro you could take it to the local bank and redeem it for 35 Deutsche Pfennig, 24 French centime, .006 Slovenian talar and so on-or rather your new national currency exchanged at the market rate of that basket of 17 currencies. This way everyone would get the same amount of new national currencies for their euro and it would just be a matter of moving that currency to its respective country through FX markets. As a result, there would be no rush to dump euro because everyone would be getting the same mix of Drachma and Deutsche Marks (DM). Indeed the euro could continue to be used day to day while currency was gradually redeemed. Trading in the new currencies would start at par between the re-empowered central banks who would start seed monetary bases. The monetary bases would grow ( proportionally shrinking the euro base) as euros were redeemed for national currency to pay taxes and wages.

So lets run through how the process would work for Greece, as if it can work there, it can work anywhere. Greek bank deposits would be converted just as anywhere else, Greeks would get about three Drachma for every hundred euro, 35 (or whatever it is) DM…. The Greek government would still have to reckon with its massive debt, the payments of which would be mapped through the composite weightings of the euro to new national currencies. That is, the drachma value of each coupon payment would be linked to the European currency index.  The 3% of Greek savings denominated in Drachma would quickly depreciate as drachma were dumped for USD, DM, and gold. The upside for Greece is that its population would still be sitting on a portfolio of 35% DM and about 40% other reasonably stable currencies (Dutch guilders, Austrian Schilling &c). Greece would need to go through with the current bailout plan (payments converted to drachma), but their savings wouldn’t be affected any differently than the savings of German citizens. The readjustment of wages would take place within months rather than a decade. Starting wages in drachma could be paid at the market rate and in proportion to the composite mapping, as inflation rose drachma wages could be increased to clear the labor market.

This hardly solves Greece’s problems, they still need a bailout and partial default, but by not wiping out their national savings they have a fighting chance. Whats more, it allows the much needed opportunity to quickly adjust their export competitiveness.  With new national currencies, each country would be able to offset needed fiscal austerity with expansive monetary policy. Because the burden of coming up with 35 DM for each 100 euro coupon payment (or previously signed contract) would strain the finances of sound but over valued countries like Finland, the Bundesbank would need to commit to a 5% or so inflation target for a few years.  Lightening debt burdens through inflation is a dirty business, but because this scheme would undo the euro for good, the moral hazard is less odious than if the inflation target were boosted but the euro maintained.

I think the beauty of this strategy is that it provides a way of working through previous agreements in a fair and straightforward way. Everyone gives a little, German bond and contract holders get lower coupon payments, debtors with weakened currencies pay more but get the chance to finally stop the deflation. I think this is at least an idea on which to build.