The other exit strategy

January 20, 2010 7:01 AM

With quantitative easing on everyone's minds, pundits of all sorts talk about Central Bank exit strategies. But in The Treaty of Lisbon, which came into force across the EU on December 1st, 2009, it turns out European member states have put forward an exit strategy of a completely different kind [.pdf] .

When the Euro was initially introduced on January 1st, 1999, the merging national currencies and monetary systems was said to be irreversible. So why talk of exit strategies now?

With unease growing about the fiscal responsibility of what some in private call the "PIIGS" states (Portugal, Italy, Ireland, Greece & Spain), it seems many in the so-called "core" European nations are now openly planning for what a decade ago was unthinkable.

And this raises an interesting question - if a member state does indeed leave the union, will it be a case of publicly jumping or privately being pushed?

posted by Mutant (31 comments total)

Pretty much everything you'd care to know about the Euro can be found here, except for this little tidbit: sovereign liabilities, once denominated in Euro, will not be redenominated. Any member nation thinking of leaving the Union must carefully plan their exit to mitigate inflationary impact.

The Treaty of Lisbon has been discussed previously discussed on MeFi, but from the perspective of political machinations.

And historical trivia: there has already been one instance where a territory has ceased to be part of the European Community: Greenland, in 1985, an exit that reportedly took some six years to negotiate.
posted by Mutant at 7:01 AM on January 20, 2010 [2 favorites]

What are the consequences of a member state leaving the EU? Is it like the US, where you can join but only leave feet first?
posted by mullingitover at 7:15 AM on January 20, 2010

"Crucially, he argues that eurozone exit entails expulsion from the European Union as well. All EU members must take part in EMU (except Britain and Denmark, with opt-outs)."

So where's Sweden in his big scheme of things? Doesn't even seem to be mentioned in the report...
posted by effbot at 7:31 AM on January 20, 2010

Ah, really interesting. Remains to be seen if the EU's political legitimacy will be more weighty than economic safety when push comes to shove...

What are the consequences of a member state leaving the EU? Is it like the US, where you can join but only leave feet first?

The comparison with US isn't quite right: the EU member states don't give up their sovereignty and remain nation states. Basically they've agreed to submit to the EU's decisions in certain defined areas, hence why the EU is a supranational 'state' or entity, not a nation state in its own right like the US. On a very formal political level, little would change for Greece if it were to be kicked out: it would merely regain the competence it had devolved to the EU. On a less political level however...

Economically, Greece would suffer a huge decent in the country's economic credibility and great damage to their trade relations with EU states. For Greece this would be a real issue, especially when you add how dependent they are on EU subsidies.
posted by litleozy at 7:35 AM on January 20, 2010

Those who suspect that European Court has the power pretensions of the Medieval Papacy will find plenty to validate their fears in this astonishing text

And in pretty much all the case law: I think the EU is a great institution but I've got to admit that ECJ's general approach to questions of national sovereignty really is 'how much can we get away with: Taxation? Yeah we can liberalise that. Advertising restrictions? Hell yeah! Access to cross border health care? Why stop now? It's all about the single market whooho!

Admittedly they've cooled it recently and reigned in some of the more obscene decisions, particularly in regards to the free movement of goods and services (even genuinely non-discriminatory restrictions on services and goods need to be justified? Really?) but still... The quoted remark comes off as fear-mongering euroscepticism, but it is pretty justified given some of the stuff the court has pulled.
s
/rant spurred by today's EU law tutorial
posted by litleozy at 7:41 AM on January 20, 2010

Where's Sweden? With Britain and Denmark.

"In Sweden, the parliamentary parties agreed that EMU participation would not be possible without the broad approval of the Swedish people. In March 2003, following talks between the party leaders, the Riksdag decided that a national referendum was to be held on Swedish participation in EMU, on 14 September 2003.

At the referendum, the Swedish people rejected participation, with 56 per cent voting against and 42 per cent for. All parliamentary parties pledged to respect the outcome of the referendum. No new referendum is planned for the foreseeable future."

In other words, Sweden is out of the Euro and the Kronor has been decoupled from the ERM for more than a decade.

*Stuffs another hundred Selmas into the Hästens mattress*

But leave the EU? Not even drunks in bars talk about leaving the EU.

As for other nations leaving the EU, or being pushed out?

*Runs into street, looks up at Portugal, Italy, Ireland, Greece & Spain standing on the ledge, yells "JUMP."*
posted by three blind mice at 7:58 AM on January 20, 2010 [2 favorites]

Krugman's not a fan of the Euro

The euro is a quite different issue. Back when the single currency was being contemplated, the fundamental concern of many economists on this side of the Atlantic was, how will Europe adjust to asymmetric shocks? Suppose that some members of the euro zone are hit much harder by a downturn than others, so that they have much higher-than-average unemployment; how will they adjust?
...
Was the euro a mistake? There were benefits — but the costs are proving much higher than the optimists claimed. On balance, I still consider it the wrong move, but in a way that’s irrelevant: it happened, it’s not reversible, so Europe now has to find a way to make it work.

Countries can't devalue their currency independantly, so that means wages would need to come down nominally in order to bring wages down. Politically that's somewhat of a tough sell.
posted by delmoi at 8:25 AM on January 20, 2010

It seems to me that you can think of Europe as having three concentric levels of integration.

1. The Eurozone of nations with the single currency.(Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.)

2. The European Union: all of the above plus Bulgaria, Czech Republic, Denmark, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Sweden and the UK.

3. The European Economic Area of all of the above and the nations that have free trade with them: Iceland, Liechtenstein and Norway. I'm going to lump in Switzerland with this too: though it's not technically in the EEA, it has bilateral treaties which are very similar.

It seems to me very unlikely that the PIIGs are going to be bumped all of the way from level 1 down to level 3, or excluded entirely. I suspect that's an empty threat, encouraging them to get their deficits down, or else.

The Eurozone in its current form is an unprecedented experiment: whether you can have a monetary union without a fiscal union. At the moment interest rates are set at the eurozone level, but borrowing is set at the national level. This is always going to create a temptation for national governments to borrow and spend; since the pain this creates (either inflation, or higher interest rates to contain inflation) will be shared by everyone, but they get to reap the benefits
(political popularity, fiscal stimulus).

The British Euroskeptics are always keen to talk up the problems of the Eurozone. But since this experiment is new, no-one can know for sure if it will work or not.

If it fails, it may result in more Eurozone control over fiscal policy, rather than moving the nation out of the Eurozone. If a nation leaves the Eurozone, it could panic the markets about the stability of the Eurozone as a whole: even the stronger Eurozone nations don't want that to happen.
posted by TheophileEscargot at 8:26 AM on January 20, 2010 [2 favorites]

While I haven't had a chance to read the ECB document yet, everything thus far sounds like the ECB bit off more than it can chew. Everyone wanted the PIIGS to join up and, in the case of Ireland (IIRC), their initial rejection of membership several years back was portrayed as a potential deathblow to the EU.

This sounds like a pretty boldfaced power grab by the ECB, and while I can understand their reasoning for some rather drastic austerity measures in the PIIGS, politically, the people of those countries are probably never going to go for it. So what does the ECB do? Create some dodgy "political" authority for itself that seeks to circumvent the long drawn-out political process that would take place at the national and (I presume) the European Parliament level to impose those same measures.


Well, ECB, you got what you wished for. You wanted their money, now you have their debt. Great post, Mutant.
posted by KingEdRa at 8:31 AM on January 20, 2010 [2 favorites]

Where's Sweden? With Britain and Denmark.

Except that Sweden doesn't have the opt-out they have -- we've signed a treaty that obliges us to join the EMU, the convergence metrics all look fine, but we can't be arsed to join the ERM II (and nobody can force us).
posted by effbot at 8:31 AM on January 20, 2010

three blind mice Actually, Sweden isn't with the UK and Denmark. Sweden is cheating. It didn't negotiate an opt-out when it entered the EU, but it has achieved an unofficial opt-out by delaying stabilising the Euro-Kronor exchange rate until now (one of the Maastricht criteria is that the exchange rate should have been stable for two years).

And, quite frankly, I'm quite fed up with lazy commenters dumping the PIG, PIGS or (now) PIIGS countries in the same plate. Their public finances are quite different. Greece has a serious problem: it has a huge debt and an out-of-control deficit. Italy has a very high debt and a high structural deficit, but it hasn't suffered as big an economic shock as other European countries (mostly because it was doing quite dismally already before the crisis). Portugal has similar problems to Italy, and Ireland and Spain have low levels of public debt, and were running surplusses until just two years ago, but have been hardest hit by the crisis (because they both had particularly egregious real estate bubbles) and the loss of tax revenue, and increased expenditure (both because of Keynesian anti-crisis programs and higher social expenditure) have now turned those surplusses into deep deficits.

Spain and Ireland have in fact more in common with the UK than with Portugal and Italy, never mind Greece. There's of course the difference that Spain and Ireland are in the EMU, and the UK isn't, but, since a sharp drop in 2008, the GBP-EUR exchange rate is quite stable. After a big dollop of it in 2008, the UK is no longer resorting to competitive devaluation (possibly because a drop below parity would be a huge -though irrational- blow to national self-confidence, and would possibly be the death knell of any British government). Instead, it's having to pay higher interest rates.

And Mutant, I'm sorry, but the Torygraph has been regularly predicting the break-up of the EMU since even before its inception. It has been as reliable so far as the Seventh-Day Adventists. No news there...
posted by Skeptic at 8:46 AM on January 20, 2010 [6 favorites]

The British Euroskeptics are always keen to talk up the problems of the Eurozone. But since this experiment is new, no-one can know for sure if it will work or not.

Yeah. An article in a right-wing British newspaper criticizing the Eurozone. Certainly not a surprise. The whole "now openly planning for what a decade ago was unthinkable" is the Telegraph's take on the same PDF we can all read for ourselves.
posted by vacapinta at 8:53 AM on January 20, 2010

Mutant, regarding the first few links, why do finance people make zero the bottom of interest rates? It seems to me that the bottom should be the negative of expected inflation rates since it doesn't seem to be in the borrowers interest to hold money that is gaining interest slower than it is losing value.

And from the Fed's point of view, it's all just (mistakenly known as) printing money anyway.
posted by rakish_yet_centered at 8:54 AM on January 20, 2010

Mutant, regarding the first few links, why do finance people make zero the bottom of interest rates?
Sweden became the first to introduce negative interest rates last Autumn.
posted by Abiezer at 9:01 AM on January 20, 2010

I think it highly unlikely that Europe (or parts of its government) are actively planning to the exit or ejection of member countries; more likely this was included to allay fears of one-way federal encroachment. At most, it will be used as a stick to beat fiscal recalcitrants. I agree with other mefites that the Telegraph's editorial view on this topic isn't worth the bandwidth it takes to transmit.
posted by anigbrowl at 9:02 AM on January 20, 2010

negative interest rates

"I'll gladly pay you two chicken nuggets on Tuesday for a hamburger today"
posted by jock@law at 9:23 AM on January 20, 2010

The Euro != The E.U.

You can have one without the other, like Ice Cream and Chocolate Sauce. The question is, would you really want to?
posted by blue_beetle at 9:29 AM on January 20, 2010

Well, I don't think I'd focus so much on just one of the the sources (Telegraph) as I would the message (the ECB seems to be looking at ways to mitigate damage caused by a European sovereign default).

The markets have already been pricing this in, and while this doesn't mean a default is certain to happen, but many participants don't like what's going on and are reacting accordingly: even before the serial ratings downgrades over the past three months Greece was struggling to make payments on its external debts. Since the downgrades credit default swap premiums have sharply widened, almost daily.

CDS spreads for Irish Sovereign debt are pushing out even as Portuguese and Spanish spreads widen out against more fiscally oriented nations such as Germany. Effectively those selling the insurance (CDS') here are becoming increasingly nervous about default and asking for higher premiums. And remember, in the CDS markets default is not a binary, "stop payment" event like it is in retail space; Choudhry, 2004 lists six classes of events that may be construed as default(page 13, section 2.1.1, Credit Events -- I'm having problems with the google books link); note he assumes ISDA contract structures which are generally the most commonly used.

But of course the really interesting item that hasn't seem to have gotten much press is that the ECB saw a need to author such a paper; "Legal Working Paper Series No. 10 / December 2009", entitled "Withdrawal and Expulsion from the EU and EMU" in the first place.

Fascinating because the mechanism to expel member states hadn't been formally explored before this paper was authored. And when the Euro was launched the mantra was "irreversible". Now the ECB themselves are openly talking about such a possibility. This represents an enormous change in posture. Politicking, to be sure, But significant. Why?

Well, for starters the paper introduces the concept of "collective right of 'expulsion' from the EU or EMU" (page 32).

They discuss that idea further and seem to reach the conclusion that while they can't directly expel a non-compliant member state, they can restrict its rights.

The paper next explores "indirect avenues of expulsion", effectively discussing mechanisms to "isolate" non-compliant states, finally concluding "marginalising a Member State, even if not formally expelling it, would be not be impossible, but none of the avenues for achieving it would be ideal. Persuading a Member State to withdraw, by making use of the proposed exit clause or resorting to the regular Treaty revision procedure, may be the better option" (page 38).

And a footnote on 43 seems to sum it all up in one concise sentence

"if explusion is impossible this may deprive Member States of an incentive to comply with their obligations."

I tend to agree with comments up-thread they'll use these mechanisms to effect changes in the "non-compliant" member states. But anyone who has been watching this knows nations such as Germany has been very vocal with respect to fiscal responsibility. Now they've got a stick to beat them with.

But as in any market event there was winners and there are losers; here we're seeing the US Dollar at short term highs against the Euro.
posted by Mutant at 10:08 AM on January 20, 2010

That Torygraph article seems to be the usual scaremongering - the key point it elides is that any secession would be at the option of the country itself, not of the European Union. From the abstract of the paper:
"a Member State’s expulsion from the EU or EMU, would be legally next to impossible." and further on "there is no treaty provision at present for a Member State to be expelled from the EU or EMU". That said, the thought exercise on potential indirect methods of expulsion is quite interesting - I like the prospect of a parallel EU existing but with one fewer member.
posted by patricio at 10:21 AM on January 20, 2010

On preview, the CDS market is rather betting on a bailout for Greece isn't it? The term structure has inverted which means that the market thinks it is more likely for a default to happen sooner rather than later - i.e. a bust now or a bailout and relative safety.

Agree about the message, though the conclusion of the paper perhaps isn't overly threatening.

Mutant - what is that Choudhry link? The list of credit events is quite wrong
posted by patricio at 10:31 AM on January 20, 2010

That said, the thought exercise on potential indirect methods of expulsion is quite interesting - I like the prospect of a parallel EU existing but with one fewer member.

They could call it "The Ancient Mystic Society of No Greeces."
posted by albrecht at 10:44 AM on January 20, 2010

The EU has always been playing this game of "Let's Be More Like America, Only Better, Only Not." The US has suffered from numerous asymmetric economic shocks over the years, and in a sense is suffering from them now, e.g. compare the impact of the recession on the West vis-a-vis the South Central states. But in every case the shocks usually get leveled out -- the Feds may prop up a state's finances or help them through pork barrel projects. And you rarely hear, say, the people of New York complain that their tax money is going to help an economically distressed Oregon. It's just understood that it's done.

Europe, though, doesn't like to do this. Even when the EU was sending boatloads of cash to Ireland to improve their infrastructure there were naysayers in European capitals. When they started pulling in Eastern Europe, the cries just got louder every time they sent a euro outside the borders of Germany, France, or the UK. So now that they're saddled with the debts of countries they've half-heartedly tried to prop up, they're whining and whinging.

Tossing the PIIGS states from the Eurozone solves nothing -- after all, most of their debt is held within the EU already, which means that if Greece defaults it'll hurt the EU regardless of Greece's current choice of currency. Tossing them completely out of the EU would only bring about the end of the EU itself (which, again, the Torygraph would love to see more than anything else). The paper is grasping at straws trying to find a way to isolate the effects of a country's bad economic state from the rest of the EU, but it's clear it really can't be done without changing the ground rules dramatically and in ways that would let a Euroskeptic government with a decent economy bail on the entire arrangement. And I don't think the EU wants to leave that door open for the Tories to walk through when they take over Westminster this spring.
posted by dw at 10:53 AM on January 20, 2010 [2 favorites]

patricio -- "The list of credit events is quite wrong "

My link to the ISDA docs was broken, and I'm headed out - do you have something more current? I can't find Das or Tavakoli online at the moment.

"I like the prospect of a parallel EU existing but with one fewer member"

That is a point the paper does seem to focus on; first linking a voluntary resignation from the EMU with expulsion from the EU - "the only way to withdraw from the EMU is to withdraw from the EU" (page 28).

Page 37 introduces an interesting distinction, "mainstream Member States", in the context initially of identifyin those nations they later refer to as "minimalist, less integrationist or otherwise uncooperative Member States". (uhmm, wow. interesting choise of words there).

On page 38 they continue to reinforce this distinction, going so far as to speculate about the creation of "a new, treaty based partnership with an independent institutional structure outside the framework of the "old EU", going so far as to call it "a new Union". Presumably of compliant member states.

Although they discount this possibility, we are, of course, reading what will undoubtedly the the first paper on this subject; the ECB is effectively soliciting input and ideas on the subject, once again reiterating the significance of this paper. Irreversible is no longer a word in their vocabulary.

If some of the "non compliant" member states don't get their affairs in order the "mainstream" members are clearly going to take action. Fascinating.
posted by Mutant at 11:11 AM on January 20, 2010

Some previous articles of the Daily Telegraph about the Euro:

10 Jun 2002: Political considerations in member countries could cause early break-up of the euro

07 Feb 2004: Eurozone 'may have a reverse gear'

20 Apr 2005: Markets 'too complacent about break-up of eurozone'

07 Jun 2005: Finance ministers meet to calm fears over euro

18 Sep 2006: Why break-up of faltering euro could be the way ahead

02 Dec 2007: The credit crunch could crush the euro

08 Jun 2008: After ten years the euro is facing up to its first serious test

25 Sep 2008: The euro crisis is about to begin

This is just a selection, but you can guess the rest. Nobody can accuse the Torygraph of lack of consistency when it comes to its reporting about the euro...
posted by Skeptic at 1:00 PM on January 20, 2010 [6 favorites]

Interesting post Mutant, thanks.
posted by triggerfinger at 1:25 PM on January 20, 2010

Interesting, but perhaps limited sovereign defaults are simpler to implement and less dangerous than expulsion?
posted by jeffburdges at 1:53 PM on January 20, 2010

Explanation:

Deutsche Mark was a very very strong currency. Unfortunately the German economy was, due to reunification and other factors, in a much worse shape then thought and Germany joined the EURO with a highly overvalued currency. The UK would have made the same mistake if they had joined at that time since the pound was IMHO overvalued.

What happened? Mainly two things:

First:

* Many countries experienced an economic boom due to interest rates on credit that were unknown until the EURO came. Property bubbles were created in countries like Spain and possible others and these countries enjoyed a big party that lasted many years.

* Germany was (and is) a highly export oriented economy. The salaries were so high that it experienced problems and labor cost increases over the years were often below inflation rate. After many years of obtaining from salary increases in Germany - and very high salary cost increases in the PIIGS countries, sometimes in the double digits per year - Germanys labor costs were comparably low again.

Now:

The party is over for the PIIGS countries. After the construction boom came - inevitably as Ludwig van Mises would say - the collapse. And while Germany never had any real estate boom (Real Estate prices remained basically the same since 1991) it stayed competitive in labor costs but it citizens lost a lot of buying power. Hence in Germany, very little is consumed and everything focused on the export.
Back to the PIIGS countries. The situation that their industrial economy has difficulties competing against Germany has happened before. The obvious solution was to devalue their currency. This "balanced" things out on the one hand but was the reason on the other hand why the "Deutsche Mark" was in such demand. This option is not available anymore due to the EURO. One of the options they have is not to increase salaries anymore and basically wait until they become competitive again. I doubt that the PIIGS countries do have the financial discipline to brutally cut costs on and keep salaries down at the same time. Few governments would survive such politics.

Currently PIIGS countries pay much higher interest on their government debts than Germany. I think Greece pays basically double on a 10 year bond what Germany is paying. A hint of things to come. Basically the question is now if Germany and maybe France and smaller countries like The Netherlands will bail Greece out. The question is also what would happen IF such a country leaves the EURO since the debt would remain in EURO and can't be paid easily by inflation or the printing press. Look at Iceland. Rule of thumb: Never accumulate debt in any other currency than your own.

I have a bet with a friend running since over 3 years that Italy will leave the EURO. Unfortunately I don't know any trading strategy that I could run to benefit from this. Feel free to suggest one. The only thing I can advice to all the women I know that want to retire in Italy (Yes, Italian men, I know) that I would wait to buy a house there. Besides the shrinking population in Italy, it will be much cheaper to buy it in Liras in the future then with EUROs now.

And yes, the Euro was a bad idea.
posted by yoyo_nyc at 2:49 PM on January 20, 2010 [1 favorite]

The conclusion that booting Greece from the Eurozone will boot them from the E.U. seems completely absurd, even if the treaties currently say so, people will support changing those treaties.

I'm also unsure how you'd ever overcome the obstacle that people simply will not want the new drachmas, i.e. all mobile Greeks will simply move their bank accounts abroad, creating a run on the Greek banks.

Isn't inflation simply a tax on savings and assets? If the savings can flee, then save yourself the hassle by taxing only the assets from the get go. Indeed, Greek landholders have benefitted more than normal Greeks from their country's piggish policies, so let them pay up via property taxes.
posted by jeffburdges at 3:22 PM on January 20, 2010

Although it's hardly new for the Telegraph to be suggesting that countries could leave the EU, it does worry me when the idea seems to gain traction. Mostly, this is because the deeply Eurosceptic parties, like the UK Independence Party, will likely gain some support from this (they're the second largest British party in the European Parliament, despite holding no seats at Westminster).

That's a problem because UKIP's major policy plank is "we'll leave the EU", and that's frequently all anyone knows about them. So people could well vote for them on the basis of not liking the EU very much, and not realise that they are very, very right-wing (much more so than the Conservatives) - for example, they don't support progressive taxation in any form. It could lead to right-wing politics becoming much more dominant in the UK, at a time which has actually been looking pretty hopeful for liberals, given how far David Cameron had to move the Conservatives into the centre to gain any traction at all.
posted by ZsigE at 5:06 PM on January 20, 2010

rakish_yet_centered: "why do finance people make zero the bottom of interest rates"

Obviously zero is a lower bound because dollars invest under a matress at 0 percent. If I'm reading your question correctly, you want to raise the lower bound (we have terms for this in computer science but nobody uses / remembers them) to be the inflation rate, but there's no lower bound to inflation.
posted by pwnguin at 8:48 PM on January 20, 2010

there's no lower bound to inflation.

Yes, there is. But then it is called deflation. Besides the - IMHO absurd - idea from Silvio Gesell, there is no reason why the interest on deposits can't be negative. And it has happened: http://money.cnn.com/1998/11/06/economy/japan_bank/
posted by yoyo_nyc at 10:55 AM on January 21, 2010