Euro exit: a likely sce­nario

Financial Mirror (Cyprus) - - FRONT PAGE - By Dr. Jim Leon­ti­ades

The main op­po­si­tion par­ties in both Cyprus and Greece have pressed for ma­jor changes re­gard­ing Eu­ro­zone poli­cies. They com­plain that not only is growth in the Eu­ro­zone lack­ing but that Eu­ro­zone poli­cies con­ducive to growth are also lack­ing. Dis­sat­is­fac­tion has reached the point where leav­ing the com­mon cur­rency has been a se­ri­ous sug­ges­tion ad­vanced by the main op­po­si­tion par­ties in both of these coun­tries.

Rea­sons for dis­sat­is­fac­tion with mem­ber­ship in the Eu­ro­zone are not hard to find. Cyprus and Greece are ex­pe­ri­enc­ing de­pressed eco­nomic ac­tiv­ity and record lev­els of un­em­ploy­ment. Na­tional debt is at such lev­els (174% of GDP for Greece and for Cyprus 105% and ris­ing ) that it will be years be­fore they can pay it down to ac­cept­able lev­els. Even then, gov­ern­ment ex­pen­di­tures will be lim­ited so as to stay within Eu­ro­zone im­posed debt lim­its. So, why not leave the Euro?

When Cyprus adopted the Euro, the change was from one rel­a­tively sta­ble cur­rency, the Cyprus pound, to an­other strong cur­rency. The sit­u­a­tion to­day of an eco­nom­i­cally weak, heav­ily in­debted, Cyprus is not com­pa­ra­ble. Any hint that a mem­ber of the Eu­ro­zone was pre­par­ing for a uni­lat­eral exit, to drop the Euro and adopt a new cur­rency would have wide­spread fi­nan­cial and po­lit­i­cal reper­cus­sions. The idea that this could be done quickly and with lit­tle out­side at­ten­tion is com­pletely un­re­al­is­tic.

The nec­es­sary plan­ning for such an exit could hardly be kept se­cret. There would be de­bates in par­lia­ment. Plans would have to be made for a new cur­rency, i.e. new ban­knotes. When Cyprus re­placed the pound with the Euro, months of prepa­ra­tion were re­quired, in­clud­ing the re­pro­gram­ming of bank com­put­ers, chang­ing ATM ma­chines and all coin op­er­ated ma­chines, distri­bu­tion of new notes to lit­er­ally thou­sands of out­lets. In short, the mere in­ten­tion to exit would be com­mu­ni­cated to all well in ad­vance.

The in­ter­na­tional rat­ing agen­cies, re­act­ing to even a hint of a pos­si­ble exit from the Euro on the part of a heav­ily in­debted mem­ber coun­try emerg­ing from bank­ruptcy, would rush to down­grade that coun­try’s credit rat­ing to junk, if not al­ready at that level . With no ac­cess to Eu­ro­zone credit and in­ter­na­tional mar­kets closed to us, de­val­u­a­tion of the new cur­rency would in­evitably fol­low.

Ci­ti­zens of an ex­it­ing coun­try would quickly re­alise that that the de­val­u­a­tion of the new cur­rency was highly prob­a­ble. There would be a rush to with­draw money from the banks. Euro ban­knotes, or nearly any for­eign cur­rency, would be ea­gerly ac­cu­mu­lated and stored or prefer­ably sent abroad. A thriv­ing black mar­ket in for­eign cur­rency and Eu­ros would ap­pear al­most overnight. The prices of all im­ports, cars, house­hold goods, petrol, medicine, even many food items, would soar. Our own tar­iffs would have to be ad­justed (up­wards) to take into ac­count the is­land’s more lim­ited abil­ity to pay with a de­val­ued cur­rency.

Even more im­por­tant would be the po­lit­i­cal con­se­quences. Any uni­lat­eral exit from the Eu­ro­zone would by met with hos­til­ity by the re­main­ing mem­ber coun­tries. A uni­lat­eral exit, or even an at­tempt at a ne­go­ti­ated exit, would trig­ger a cri­sis through­out the Eu­ro­zone as doubts about the whole sin­gle cur­rency project hit fi­nan­cial mar­kets. If one coun­try leaves, will oth­ers fol­low? An al­ready none too suc­cess­ful com­mon cur­rency union would lose cred­i­bil­ity. The Euro it­self would plunge rais­ing the price of oil and many other im­ports to the re­main­ing mem­bers of the com­mon cur­rency.

These re­main­ing Euro coun­tries would be any­thing but well dis­posed to­ward the ex­it­ing coun­try. Ex­pul­sion from the Euro­pean Union it­self would be a vir­tual cer­tainty. In the case of Cyprus, a small is­land na­tion would be iso­lated in one of the most volatile and dan­ger­ous re­gions of the world.

The po­lit­i­cal par­ties (both Cyprus and Greece) propos­ing a Euro exit have been silent on how they would deal with the likely ad­verse con­se­quences of such an exit, only some of which are in­cluded in the above sce­nario.

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