Had Phone Call From A Greek Client Today ..

[ShedDweller]

My relations with my Greek clients are sort of interesting .. I have a very good Greek friend who lives locally who tells me what to say and when to say it .. Basically they take nine months to pay .. but, I've been working with several different companies for a while now .. The trick is to make 100% sure they pay all the up front expenses and then you get a nice surprise 9 months later ..

Got a phone call today about four days work next week .. as they were booking it I was thinking .. hang on a sec what happens if the unthinkable happens and Greece drops out of the Euro how on earth do I get paid and what do I get paid ..

The client is the Greek subsidiary of an American company and I was told ..

"Because you are a foreigner we are allowed to pay you in Dollars, because if we agree to pay in Euro's we are not sure that by the time you get paid Greece will still be in the Euro." So you will be paid in Dollars Via the Head Office in New York. The good news for you is it's 30 days instead of the Greek payment system AND the overseas transfer does not have to be approved by the Greek Ministry of Finance ..

This whole idea that "Greece will drop out of the Euro" just doesn't make sense to me because all debts are in Euro's and they can't just switch those over to a new currency overnight. My client was telling me that "Yes it is being talked about and of course we (ie small -medium sized business and poor people not in Public service) are going to suffer badly because the credit we have given out to our clients will be devalued but our liabilities will remain in Euro's." Then he hit the killer .. "We will not now accept Euro's from Greek clients all the deals have to be done in Dollars, you can accept Euros from Germany or the UK no problem." They have NO work from Greek clients, (and neither do any of their competitors because they are so frightened of working for a client where debt may not be enforceable at the level they invoiced for). They will and do work for the Greek government because the Greek government is GUARANTEEING that they will paid in Euros regardless.

I just can't see any way that they could pull out of the Euro without also pulling out of the EU .. and I don't see how they can do that either .. Does anyone have any idea how you could do that ? Are there any historical precedents ?

The only Historical precedent I can think of is that of Czechoslovakia after the first world war .. The moment it was cut off from the Hapsburg Empire they shut the borders and stamped every banknote in circulation as being Czechoslovak (and thus secured their currency as THE hard currency in Central Europe). But given that the idea of the change of currency would be the opposite ie all currency in circulation is worth a fraction of it's value, I don't know that that would work.

Any other ideas of how they could do this ?

[SarahBell]

Why can't greece leave the euro?

[interestrateripoff]

http://www.ecb.int/pub/pdf/scplps/ecblwp10.pdf

Abstract

This paper examines the issues of secession and expulsion from the European Union

(EU) and Economic and Monetary Union (EMU). It concludes that negotiated

withdrawal from the EU would not be legally impossible even prior to the ratification of

the Lisbon Treaty, and that unilateral withdrawal would undoubtedly be legally

controversial; that, while permissible, a recently enacted exit clause is, prima facie, not

in harmony with the rationale of the European unification project and is otherwise

problematic, mainly from a legal perspective; that a Member State’s exit from EMU,

without a parallel withdrawal from the EU, would be legally inconceivable; and that,

while perhaps feasible through indirect means, a Member State’s expulsion from the EU

or EMU, would be legally next to impossible. This paper concludes with a reminder that

while, institutionally, a Member State’s membership of the euro area would not survive

the discontinuation of its membership of the EU, the same need not be true of the former

Member State’s use of the euro.

Withdrawal for Greece would be very messy, the problems for the Greeks would be what happens to Euro debt, there would probably be an immediate flight of Greek Euro's from Greece to other safer European banks like the Germans, although paradoxically if Greece defaults as withdrawal would surely mean then the Germans banks would be in crisis.

A Greek withdrawal would also probably trigger Spanish, Portuguese and Italian exit from the Euro.

If the Greeks are planning this they will shaft everyone.

It seems that the big corporations are hedging that the Greeks will withdraw which is why they don't want payments in Euro's.

[ShedDweller]

Why can't greece leave the euro?

Well it can but. The point being I can't see how .. how could Greece drop out of the euro ?

What would be the sequence of event's ?

If you decide to change from the euro to some new currency what happens to loans made in Euros? What would happen to buisness debts ? Cross border Buisness debts ? What about the cash floating around in the system ? How do you tell everyone ? Because the "Old" currency is going to be worth more than the new currency how do stop people hoarding cash in Euro's, Especially as Greece has a such a huge cash economy (40% of transactions are "Black") Surely you would end up with the "Black" market running in Euros and the Legit market in drachmas. The only way you can change the currency is outlaw the use of Euros. I just can't see a way that you could do that and not have the country fall to bits ..

Are loans made in euros then converted into the new currency ? Who takes the Loss when the currency devalues ? If a house loan is made to a Greek for €100000 he owes that to the Greek bank . the Greek bank owes a CDO to a German or other international lender .. The bank may be forced to change the loan to a new currency .. but the bank obligations are in Euro's and there is no way out of that ..

I'm not saying it can't drop out of the Euro .. I just can't see how it could in practical terms ..

[plummet expert]

Of course they can leave the Euro! Their central bank would issue Drachma's and exchnage them for all Euro cash held. All bank deposits would be revalued and quoted as Drachma. If the markets don't like the rtate against Euro set by the Greeks on floatation, then a devaluation would happen like any other currency.

They need not leave the EU. The Uk and Norway retain their own currency and are members.

The Euro may well not survive in present form. Good ridance! I think it damages the EU. It should be a free trade area only.

Very interested your customer is resorting to USD to trade. Probably be the same in Spain next.

[interestrateripoff]

http://uk.reuters.com/article/idUKTRE5BL1OB20091222

Expelling a country from the EU and monetary union was also technically possible under the newly-ratified Lisbon treaty, although very unlikely, ECB legal counsel Phoebus Athanassiou said. The legal working paper looks at the implications of a new exit clause in the new EU treaty, which spells out arrangements for the voluntary withdrawal of member states from the EU.

"Recent developments have, perhaps, increased the risk of secession (however modestly) as well as the urgency of addressing it as a possible scenario," the author said.

Withdrawing from monetary union was not specifically mentioned in the exit clause, but the paper concluded that if a euro zone state withdrew from the common currency region, it would also have to leave the wider EU -- although not necessarily give up the euro completely.

"Even if institutional membership of the euro area would not survive a member state leaving the EU, this would not necessarily prevent it from using the euro," the paper said.

Expulsion from the EU or monetary union was technically possible but "would be so challenging, conceptually, legally, and practically, that its likelihood is close to zero," the paper said.

Reuters summary of the ECB paper.

[interestrateripoff]

http://www.jdawiseman.com/papers/finmkts/deutsche-zentralbank.html

The end of EMU: How Germany might leave

Julian D. A. Wiseman

Abstract: A country in the eurozone can, without being in breach of the Maastricht Treaty, create a new central bank controlling the monetary policy of a new currency. This loophole in the Maastricht Treaty is not widely known.

An earlier essay (The end of EMU: legal ramifications), discussed the non-recoverability of the eurozone’s members’ former national currencies. It concluded that even if a country (or all countries) left EMU, euro debts and euro assets would remain in euro.

This essay discusses in more detail the mechanism by which a leaving country would introduce a new currency. This essay has been informed by many conversations with and a paper*1 by William Porter of LEDR and CSFB, and also by a dissertation on currency boards, dated 1992, by Kurt A. Schuler, then of George Mason University. Of course, the errors and opinions herein are those of this author, Julian Wiseman.

So for the purposes of this essay we assume that Germany has had enough. For whatever combination of political and economic reasons (in so far as they are distinct), Germany wants to introduce a new currency under the control of the German authorities.

One of Germany’s options is what could be labelled the ‘1948’ strategy. All German citizens (or all those who satisfy some residency condition) would be issued with a thousand Neue Deutschmarks (NDM). Legislation would be enacted that:

*

made the NDM the only legal tender on German soil;

*

ensured that taxes would be payable only in the new money;

*

paid state employees in this currency; and

*

created institutions (such as a central bank) to run monetary policy.

There are variations on this theme. The ‘1990’ variation might allow some euros to be converted into the Neue Marks, perhaps with an upper limit per eligible person. Unfortunately, this particular variation would suffer from ‘leakage’. Italian holders of euro, unable to exchange their euros with the German state themselves, would buy goods from or lend money to Germans, and the Germans would then exchange the old euro. In practice, all Germans would exchange all that they were allowed to, so there might be little practical difference between the 1948 and 1990 techniques.

Before remarking on why the German state might be reluctant to try such a thing, some additional notes are appropriate.

What would determine the worth of the Neue Mark? One of the most important influences is the number issued. If ten times as many were issued, then all other things being equal, each would be worth one tenth as much.

The taxation regime is also pertinent. Some authors, especially Warren B Mosler in his article on Soft Currency Economics, argue that the primary purpose of taxation is to give a purpose and hence a value to money. Without going that far, it is clear that if the German state imposes a tax on cigarettes of 10 million new marks, then the new mark may well have to be worth less than if the tax were 10 new marks.

That said, there is a problem with the 1948 and 1990 strategies. The problem is that they would be in manifest breach of Article 106 (ex Article 105a) of the Treaty establishing the European Community (the Maastricht Treaty)*2.

1. The ECB shall have the exclusive right to authorize the issue of bank notes within the Community. The ECB and the national central banks may issue such notes. The bank notes issued by the ECB and the national central banks shall be the only such notes to have the status of legal tender within the Community. *3 *4

2. Member States may issue coins subject to approval by the ECB of the volume of the issue. The Council may, acting in accordance with the procedure referred to in Article 189c and after consulting the ECB, adopt measures to harmonize the denominations and technical specifications of all coins intended for circulation to the extent necessary to permit their smooth circulation within the Community.

So Germany cannot legally issue banknotes except with the permission of the European Central Bank, permission unlikely to be forthcoming. Germany could walk out on the Treaty, but in practice this would mean walking out on the whole European Union. That may well be more than a German politician could carry off.

What is not widely known is that Germany could introduce an entire new currency, in an entirely orderly manner, without breaching the Maastricht Treaty.

Of course, once Germany took the initial steps towards sneaking a new currency into existence, its negotiating position within the community would be hugely advanced. Other eurozone members, aware that a German exit would destroy the value of the euro, would be willing to make significant concessions to keep Germany inside. Such game-theoretic jockeying increases the chance that a German politician would want to threaten such a trick.

How would this work?

*

The key vehicle would be a state-owned bank, most likely created for precisely this purpose. Let us name it the Deutsche Zentralbank (DZB), though there are other more mischievous possibilities such as De Duits-Nederlandse Bank.

*

The DZB would be an ordinary commercial bank (much as was the Bank of England from 1694 to 1946). However, the state would guarantee all the obligations of the DZB.

*

The DZB would issue zero-coupon perpetual puttable securities. As we will soon see, these will look and function just like money; but to avoid a breach of the Maastricht Treaty, they won’t actually be legal tender. To emphasise the fact that, these are not ‘money’ for Maastricht-Treaty purposes, we refer to them here as ‘securities’.

*

These securities would need to be given some value. Their value will derive from the fact that they are ‘puttable’. At any time until three years after the DZB first issued these securities, a holder may sell a security back to the DZB, for some predetermined amount of foreign currency. This predetermined amount might be, for example, the holder’s choice of one US dollar or sixty British pence. The DZB would also state that, after three years, the DZB would not necessarily continue to be willing to redeem these securities at the same price.

*

The securities would have no final maturity date (hence ‘perpetual’), and make no interest-payments (hence ‘zero-coupon’).

*

The securities would be available in two forms. They would be available in bearer form, printed on high-quality paper, in denominations of 1, 5, 10, 20 and 50. Each denomination would carry a portrait of a famous German composer, each would have security features, and each of these bearer securities would have an individual serial number. In other words, they would walk and talk like banknotes, even though they would legally be a bearer security.

*

The securities would also be available in electronic form, held ‘on account’ with the DZB. The DZB may well choose to pay interest on deposits left with it (the interest itself being paid in securities), and to charge a slightly-higher rate of interest on overdrafts. Overdrafts would only be permitted if the borrower provided eligible collateral: bonds issued by a Aaa-rated government, denominated in one of US dollars, British pounds, Japanese yen or Swiss francs. Of course, the interest rates set by the DZB would amount to, though not be called, monetary policy.

This would not be in breach of the Maastricht Treaty: the President of the Bundesbank (an entirely different institution to the Deutsche Zentralbank) would continue to attend and vote in ECB meetings, and Germany’s place in the various EU institutions would continue, unruffled by the allegedly-commercial transactions into which the recently-formed DZB was entering. Germany could and would ‘plead innocent’.

I'm not sure if the Lisbon Treaty has closed this loophole or not but it's an interesting paper, I would assume that if Greece was to go down this road we should be expecting some of the above steps shortly.

[non frog]

Of course they can leave the Euro! Their central bank would issue Drachma's and exchnage them for all Euro cash held. All bank deposits would be revalued and quoted as Drachma. If the markets don't like the rtate against Euro set by the Greeks on floatation, then a devaluation would happen like any other currency.

....

Shouldn't cost more than about €100M. I'm sure the Greek government has that stuffed down the back of a sofa somewhere

[interestrateripoff]

http://www.zerohedge.com/article/morgan-stanley-warns-germany-may-decide-secede-emu

From Zerohedge on 04/15/2010

A fantastic overview of all the game theory aspects embedded in the European crisis, from Joachim Fels, head of Euro research at Morgan Stanley.

* Somewhat paradoxically, the show of solidarity for Greece by other euro area members and the ECB raises the risk that the euro will break apart eventually.

* Seceding from the euro area to devalue is very costly and risky. But seceding to revalue and introduce a harder currency is easier. Germany might opt to do so one day.

* The road to such a break-up scenario leads through even more fiscal profligacy and divergence in the euro area, a politicisation of monetary policy, and a weaker currency. Recent events suggest that the trip down this road has started.

A pyrrhic victory… The joint euro area/IMF financial backstop package and the ECB’s recent climb-down on its collateral rules have clearly reduced the short-term liquidity risks for Greece. However, as our European economists have emphasised, long-term solvency risks remain firmly in place. More broadly, and more worryingly, recent developments significantly raise the (long-term) risk of a euro break-up, in our view.

… which gives rise to moral hazard: The bail-out and the ECB’s softer collateral stance set a bad precedent for other euro area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time. If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union. And because the Maastricht Treaty does not provide for the possibility of expelling euro area members, the only way how Germany could achieve this would be by leaving the euro to introduce a stronger currency.

Seceding to revalue is easier: It has been our long-standing view that such a break-up scenario – where a country or a group of countries want to leave to introduce a stronger currency – is more likely than a scenario where a country wants to leave to devalue. The reason is that the costs of leaving to devalue are extremely high.

* First, borrowing costs for the seceding country would likely rise significantly as investors will demand a currency and inflation risk premium.

* Second, while contracts between parties in the seceding country could by law simply be redenominated in the new currency, redenomination would not easily apply to cross-border contracts. Foreign creditors would still demand to be repaid in euros (‘continuity of contract’). Thus, a country that secedes and devalues would still have to honour its foreign-held debt in euros and would thus face a rising debt burden. If it decided to default instead, it would, at least for some time, be totally shut off from foreign financing.

* Third, a country that decided to leave the euro to devalue would immediately face a bank run by domestic depositors who would want to shift their funds into banks in other euro area member countries. This would provoke a financial meltdown which could only be prevented by a freezing of bank deposits and the imposition of strict capital controls.

By contrast, none of these costs would apply for a country that wanted to secede in order to revalue. Its borrowing costs would likely fall rather than rise as it would attract an inflow of funds

[ShedDweller]

Of course they can leave the Euro! Their central bank would issue Drachma's and exchnage them for all Euro cash held. All bank deposits would be revalued and quoted as Drachma. If the markets don't like the rtate against Euro set by the Greeks on floatation, then a devaluation would happen like any other currency.

They need not leave the EU. The Uk and Norway retain their own currency and are members.

The Euro may well not survive in present form. Good ridance! I think it damages the EU. It should be a free trade area only.

Very interested your customer is resorting to USD to trade. Probably be the same in Spain next.

But HOW ? This has never been done before, when it has happened before, for instance the replacement of the French Franc you have a period where the new and old currencies are both valid .. and then the old currency is phased out ..

How do you "Phase out" the Euro ? It's still legal tender .

[Bloo Loo]

leaving is easy.

Greek banks would be beauraux de changes, convert the existing acounts to Drachsmas or whatever.

As for creditors of Greece....tough....they made their beds, now they had better plan for the inevitable.

[interestrateripoff]

http://www.openeurope.org.uk/media-centre/article.aspx?newsid=2696

Gisela Stuart of the Labour Party has written an article in Die Welt:

Greece, Portugal and Spain are in far worse positions than Germany was then. Within the existing monetary arrangements, there are only two “solutions” to the current mess. First, is a continuous transfer of funds from the current account surplus counties (in effect the German-bloc). A one-off payment (even if spread over three years) will not work: it would have to be an annual payment in perpetuity, on lines similar to the transfers from west to east Germany after unification. The scale of these would be huge, possibly euro 35-40bn a year for Greece alone (and much larger if similar arrangements had to be made for other countries). This would wreck Germany’s own economy and public finances. The second “solution” would be a massive devaluation of the euro. A small devaluation would not be enough for Greece and the others (though it would help Germany), but the necessary scale of depreciation, would set off very high inflation in Germany. For obvious reasons, neither of those “solutions” will happen, or if they did would involve economic, financial (and possibly political) disaster in Germany.

There is no example in history when a country has got out of difficulties like those of Greece without devaluation and/or default. If Greece and the other “Club-Med” countries were to default and leave EMU it would have huge implications for the banking system in Germany and elsewhere, a default by Spain would probably wreck Germany’s which might have to be nationalised. The least bad option would be for the German bloc to leave EMU. Germany’s banks might still have to recapitalised, but it would be less costly doing it directly than it would indirectly by trying to “rescue” Greece. However there is no way out of this mess that will not be painful for all countries within EMU as well as the wider world.

EMU was a political project imposed on unenthusiastic electorates by political leaders in a hurry. However, it was based on some very bad economics and ultimately bad economics leads to bad politics which we are beginning to see. The political leaders of EMU and IMF have concocted a scheme that may provide a breathing space, but contrary to Alan Greenspan’s belief, a problem postponed is not a problem solved.

More at the link.

It would appear that the Germans aren't too happy about this Greek bailout package.

Clearly someone is going to panic and as Fred said if your going to panic, panic first. We appear to be in a game of chicken, who's going to blink first Germany or Greece?

[interestrateripoff]

http://www.jdawiseman.com/papers/finmkts/emu-breakup.html

So how can EMU end?

Let us say that, for whatever reason or reasons, Germany wished to leave EMU. How could it be done? Germany could introduce a new currency, and declare it to be the only legal tender within German jurisdiction. To encourage the use of new currency, Germany might make taxes payable in the new currency, and might make the new currency mandatory for certain forms of contract. This new currency would be entirely under the control of the German authorities, and they might or might not choose to delegate this control in whole or in part to an independent central bank.

Alternatively, Germany could make a different currency legal tender, perhaps the dollar or the pound or the Swiss franc. For the purposes of this exposition the effect would be similar.

So far, so easy. But would happen to existing euro-denominated debts?

This question might be irrelevant. In January 1921 a German newspaper cost 0.3 marks; by the end of 1922 it cost 70 million marks. A repeat of such a hyperinflation would make a debt of several hundred million euros so small as to not be worth the squabble. Of course, inflation is now below 2%, so manic devaluation of money now seems unlikely — but equally a German departure from the euro zone now seems unlikely. But if we assume a German departure, hyperinflation becomes a probable reason.

In any event, whether or not there has been hyperinflation, a departing country has only one sensible course of action. Outstanding euro obligations should continue to be payable in euro. This would be in the economic interests of the departing country, of those remaining in the euro zone, and of those countries that never joined.

The alternative is disastrous. We have seen above that obligations in the likes of ECU, DEM, FRF, and the others are ‘stirred’ together. A departing country might be able to convert some euro debts into its new currency — possible methods are discussed below — but it cannot convert all.

Converting some would cause mass insolvency amongst financial institutions. Consider the (somewhat simplified) position of a bank, with which a total of ten billion euros has been deposited, and which has in turn lent these ten billion euros to customers and to other financial institutions. Now have some of these obligations converted into a new more valuable currency. If the bank’s assets (its loans to others) were converted, it would have a windfall profit (and therefore a windfall loss for someone else). If its liabilities are converted (others’ deposits with it), a loss, and perhaps bankruptcy, would follow. Such a partial ‘un-euro-isation’ would near-randomly redistribute wealth, collapsing many financial institutions.

But what if a government still wanted to enforce euro debts in its new currency. Could it do so? The answer is that it could try, and not totally fail.

Recall that we were considering the case where a large EMU member, say Germany, quits EMU. German legislation has complete control over contracts governed by German law. It is within the power of a government to pass a law making debts payable in the new currency (at some legislated exchange rate); or cancelling all debts, or selectively cancelling debts, or re-denominating debts owed to or by certain groups of people. (This is not unknown: the Nazis proposed a similar selective non-enforceability of German-law insurance contracts, though were persuaded otherwise by the insurers.) The point is that German law has total control over contracts enforceable under German law.

Of course, if Germany were to leave, France may well follow. And French legislators could choose what happens to French-law contracts — and that thing might not be the same thing as happens to German-law contracts.

However, German influence over debts enforceable in other jurisdictions (such as England & Wales, New York, and Japan) would be slight. So long as the euro exists (even if only as the currency of the city of Brussels), euros debts payable under the law of the jurisdictions would remain in euro. But what about Deutschmark debts? Currently, in enforcing a Deutschmark debt in (say) Japan, Japan looks to German law to define the Deutschmark, and German law says that the DEM is one part in 1.95583 of a EUR. But what if German law ceased to say that? What would Japanese law then say?

Japanese law might say that the debt had been converted into euro, and so lex monetae should no longer look to German law, but to European law. This ruling would be more likely if the debt had been converted into euro with the agreement of the parties, perhaps by being mixed with other eurozone currencies, and appearing in euros on a ‘statement’ or other written correspondence.

Alternatively, Japanese law might say that a Deutschmark debt remains a Deutschmark debt, even though it was for a while (but is no longer) repayable in euros, and therefore that German law should determine the form in which it is now to be paid.

To assist the confusion, a court in Tokyo might rule differently from one in London or in New York. In any event, it seems likely that the jurisdictions whose law governs most financial transactions would legislate to ensure ‘once in euro, always in euro’.

Swap transactions

(For this part of the essay, it is assumed that the reader has at least a basic understanding of interest rate swaps.)

In 1998, new swaps were being transacted against LIBOR in any of ECU, DEM, FRF, ITL, ESP, NLG, and PTE (LIBOR is the London Inter-Bank Offered Rate, and is computed by the British Bankers’ Association). New swaps were also being transacted against FIBOR (the cost of borrowing DEM in Frankfurt, computed by the German Bankers’ Association), PIBOR (FRF in Paris), RIBOR (ITL in Rome), MIBOR (ESP in Madrid), AIBOR (NLG in Amsterdam), BIBOR (BEF in Belgium), HELIBOR (FIM in Helsinki), VIBOR (ATS in Vienna), DIBOR (IEP in Dublin), and others.

EMU brought on a simplification. There are no longer separate London ‘fixings’ of ECU, DEM, FRF, ITL, ESP, NLG, and PTE: there is one fixing of the cost of EUR money in London, and this is copied across for the other currencies. On the continent, the European Banking Federation has created a eurozone fixing called Euribor. And (for example), the German Bankers’ Association no longer fixes the cost of borrowing DEM in Frankfurt; instead it has specified that the FIBOR fixing shall be equal to the Euribor fixing.

For the most part, this has worked smoothly. (The one exception is that the French Bankers’ Association messed up the transition from FRF PIBOR to Euribor*3.)

Consider the position of two parties who have traded a BIBOR swap (the former Belgium-franc fixing), using German-law documentation. This swap is, well, whatever German law says it is. And it settles against, well, whatever the Belgium Banking Association says it does. Of course, for now and the foreseeable future, each jurisdiction’s law says that swaps are properly enforceable, and the various eurozone national banking associations say that their national IBORs have been properly succeeded by Euribor (with a modest exception for the French mess-up). But if either of these countries leave EMU, legal uncertainty would surely increase.

Conclusion

1. The old national currencies are irrecoverable. For good or for ill, Germany cannot recover the old Deutschmark — it has been too stirred up with the other national currencies.

2. A nation can leave EMU, by introducing a new currency. In doing so, it can leave euro obligations to be paid in euro, or it can cause varying degrees of trouble by doing something different.

3. Because governments have a lot of power over their legal jurisdictions, and over the legal definition of their own currency, both past and present, and over the definition of their former national ‘IBOR’, a government that wanted to cause trouble could cause a lot of it.

[ShedDweller]

http://www.jdawiseman.com/papers/finmkts/deutsche-zentralbank.html

I'm not sure if the Lisbon Treaty has closed this loophole or not but it's an interesting paper, I would assume that if Greece was to go down this road we should be expecting some of the above steps shortly.

But all those (and this is partly my point) are a step "forward" The GERMANS could pull out easily because most people would be happier holding german currency than euros and everything would go back to DM accounting (before the euro I used to do my prices in DM) ..

This will not work in Greece because people will not want to give up their savings in euro's. How can you get people to give up a currency if they don't want to? The Germans tried and tried to get the Dutch to give up the "Old Guilder" During the occupation and they failed as it was perceived to be worth more than the German backed paper currency ..

[interestrateripoff]

http://www.futurefastforward.com/feature-articles/3660-by-philipp-bagus

By Philipp Bagus

Sunday, 23 May 2010 22:42

0diggsdigg

A specter is haunting the world, and especially Europe: the specter of a sovereign insolvency. The acute sovereign-debt crisis is largely the result of government interventions in response to the financial crisis.

As Austrian business-cycle theory explains, the credit expansion of the fractional-reserve-banking system had caused an unsustainable boom. At artificially low interest rates, additional investment projects were undertaken even though there was no corresponding increase in real savings. The investments were simply paid by new paper credit. Many of these investments projects constituted malinvestments that had to be liquidated sooner or later. In the present cycle, these malinvestments occurred mainly in the overextended automotive, housing, and financial sectors.

The liquidation of malinvestments is beneficial in the sense that it purges inefficient projects and realigns the structure of production to consumer preferences. Factors of production that were misused in malinvestments are liberated and transferred to projects that consumers want more urgently to be realized.

Solutions to the Crisis: Diverging Paths

In the present recession, the liquidation of malinvestments — falling housing prices and bad loans — caused problems in the banking system. Defaults and investment losses threatened the solvency of banks. The solvency problems triggered a liquidity crisis in which maturity-mismatched banks had difficulties rolling over their short-term debt.

At the time, there were alternatives available to tackle the solvency problem and recapitalize the banking system. Private investors could have injected capital into the banks that they deemed viable in the long run. In addition, creditors could have been transformed into equity holders, thereby reducing the banks' debt obligations and bolstering their equity. Unsustainable financial institutions — for which insufficient private capital or creditors-turned-equity-holders were found — would have been liquidated.

Yet the available free-market solutions to the banks' solvency problems were set aside, and another option was chosen instead. Governments all over the world injected capital into banks while guaranteeing the liabilities of the banking system. Since taxes are quite unpopular, these government injections were financed by the less-unpopular increase in public debts. In other words, the malinvestments induced by the inflationary-banking system found an ultimate sponsor — the government — in the form of ballooning public debts.

There are other reasons why public debts increased dramatically. Governments undertook additional measures to fight against the healthy purging of the economy, thereby delaying the recovery. In addition to the financial sector, other overextended industries received direct capital injections or benefited from government subsidies.

Two prime examples of subsidy recipients are the automotive sector in the United States (for instance, the infamous "Cash for Clunkers" program) and the construction sector in Spain. Such subsidies further delayed the restructuring of the economy. Factor mobility was hampered by public works absorbing the scarce factors needed in other industries. Greater subsidies for the unemployed increased the deficit while reducing their incentives to find work outside of the overextended industries. Another factor that added to the deficits was the diminished tax revenues caused by reduced employment and profits.

Thus, government interventions not only delayed the recovery, but they delayed it at the cost of ballooning public deficits — increases which are themselves adding to preexisting, high levels of public debt. The preexisting public debts are the artifacts of war expenditures and unsustainable welfare states. As the unfunded liabilities of public-pension systems pose virtually insurmountable obstacles to modern states, in one sense the crisis — with its dramatic increase in government debts — is a leap forward toward the inevitable collapse of the welfare state.

The Situation in Europe

In Europe there is an additional wrinkle in the debt problem. At the creation of the euro, it was implicitly assumed among member nations that no nation would leave the euro after joining it. If things went from bad to worse, a nation could be rescued by the rest of the European Monetary Union (EMU). With this implicit bailout guarantee, a severe sovereign-debt problem was preprogrammed.

The assumed support of fiscally stronger nations artificially reduced interest rates for fiscally irresponsible nations. Access to cheap credit allowed countries such as Greece to maintain a gigantic public sector and ignore the structural problem of uncompetitive wage rates. Any deficits could be financed by money creation on the part of the European Central Bank (ECB), externalizing the costs onto fellow EMU members.

From a politician's point of view, the incentives in such a system are explosive: If I as a campaigning politician promised gifts to my voters in order to win the election, I can externalize the costs of those promises to the rest of the EMU through inflation — and future tax payers will have to pay the debt. Even if the government needs a bailout (a worst-case scenario), it will happen only in the distant, post-election future.

Moreover, when the crisis occurs, I will be able to convince voters that it was not caused by me, but rather that it fell upon the country as a natural disaster — or that (better still) it was caused by evil speculators. While accompanying austerity measures imposed by the EMU or IMF may loom in the future, the next election is just around the corner. In such a situation, the typical shortsightedness of democratic politicians combines with the ability to externalize deficit costs to other nations and produces an explosive debt inflation.[1]

Due to these incentives, some European states were already well on their way to bankruptcy when the financial crisis hit and deficits exploded. Markets started to become distrustful of many government promises. The recent Greek episode is an obvious example of such market distrust. As politicians want to save the euro experiment at all costs, the bailout guarantee has become explicit. Greece will receive loans from the EMU and the IMF, totaling an estimated €110 billion over the next three years. In addition, even though Greek government bonds are rated as junk, the ECB continues to accept them and has even started to buy them outright.

There also exists the danger of contagion from Greece to those other countries — such as Portugal, Spain, Italy, and Ireland — which have high deficits and debts. Some of them suffer from high unemployment and inflexible labor markets. A spread to these countries could trigger their insolvency — and the end of the euro. The EMU reacted to this possibility and went "all in," pledging together with the IMF an additional €750 billion support package for troubled member states in order to stem the threat of contagion.

Why Governments Cannot Contain the Crisis

Can this €110 billion bailout of Greece, combined with the €750 billion of additional promised support, stop the sovereign-debt crisis, or have we crossed the point of no return? There are several reasons why political solutions may be incapable of stopping the spread of the sovereign-debt crisis.

1. The €110 billion granted to Greece may itself not be enough. What happens if in three years Greece has not managed to reduce its deficits sufficiently? Greece does not seem to be on track to becoming self-sufficient in just three years: it is doing, paradoxically, both too little and too much to achieve this. It is doing too much insofar as it is raising taxes, thereby hurting the private sector. At the same time, Greece is doing too little insofar as it is not sufficiently reducing its expenditures. In addition, strikes are damaging the economy and riots endanger the austerity measures.

2. By spending money on Greece, fewer funds are available to bail out other countries. There exists a risk for some countries (such as Portugal) that not enough money will be available to bail them out if needed. As a result, interest rates charged on their now-riskier bonds were pushed up. Although the additional €750 billion support package was installed in response to this risk, the imminent threat of contagion was stopped at the cost of what will likely be higher debts for the stronger EMU members, ultimately aggravating the sovereign-debt problem still further.

3. Someone must eventually pay for the EMU loan at 5 percent to Greece. (In fact, the United States is paying for part of this sum indirectly through its participation in the IMF.) As the debts of the rest of the EMU members increase, they will have to pay higher interest rates. Portugal is paying more for its debt already and would currently lose outright by lending money at 5 percent interest to Greece.[2] As both total debts and interest rates for Portugal increase, it may soon reach the point where it cannot refinance itself anymore. If Portugal is then bailed out by the rest of the EMU, debts and interest rates will be pushed up for other countries still further. This may knock out the next weakest state, which would then need a bailout, and so on in a domino effect.

4. The bailout of Greece (and the promise of support for other troubled member states) has reduced incentives to manage deficits. The rest of the EMU may well think that they, like Greece, have a right to the EMU's support. For example, since interest rates may stabilize following the bailout, pressure is artificially removed from the Spanish government to reduce its deficit and make labor markets more flexible — measures that are needed but are unpopular with voters.

Sovereign-debt problems, therefore, may have reached a point beyond remedy — short of default or high rates of inflation. It is likely that with the bailout of Greece we have already passed this point of no return.

Philipp Bagus is an associate professor at Universidad Rey Juan Carlos, Madrid and a visiting professor at Prague University.

Notes

[1] For the time horizon of politicians in democracies, see Hans-Hermann Hoppe, Democracy: The God That Failed (Transaction Publishers, 2001).

[2] It is thus unclear whether countries that pay higher interest rates than 5 percent will participate.

An interesting piece.

[Peter Hun]

This whole idea that "Greece will drop out of the Euro" just doesn't make sense to me because all debts are in Euro's and they can't just switch those over to a new currency overnight. My client was telling me that "Yes it is being talked about and of course we (ie small -medium sized business and poor people not in Public service) are going to suffer badly because the credit we have given out to our clients will be devalued but our liabilities will remain in Euro's." Then he hit the killer .. "We will not now accept Euro's from Greek clients all the deals have to be done in Dollars, you can accept Euros from Germany or the UK no problem." They have NO work from Greek clients, (and neither do any of their competitors because they are so frightened of working for a client where debt may not be enforceable at the level they invoiced for). They will and do work for the Greek government because the Greek government is GUARANTEEING that they will paid in Euros regardless.

Any other ideas of how they could do this ?

Debt will be converted to Drachma and immediately devalued. Lenders would have no choice but to accept.

Compare them to holders of GBP debt - devalued.

Edited May 31, 2010 by Peter Hun

[stormymonday_2011]

But all those (and this is partly my point) are a step "forward" The GERMANS could pull out easily because most people would be happier holding german currency than euros and everything would go back to DM accounting (before the euro I used to do my prices in DM) ..

This will not work in Greece because people will not want to give up their savings in euro's. How can you get people to give up a currency if they don't want to? The Germans tried and tried to get the Dutch to give up the "Old Guilder" During the occupation and they failed as it was perceived to be worth more than the German backed paper currency ..

Interestingly, I think the Germans leaving the EURO is a real possibility at some time in the not too distant future, though I am not sure a devalued EuroMed currency alone is enough to save the likes of Greece from default. It might make the burden of adjustment a little easier to manage.

[interestrateripoff]

But all those (and this is partly my point) are a step "forward" The GERMANS could pull out easily because most people would be happier holding german currency than euros and everything would go back to DM accounting (before the euro I used to do my prices in DM) ..

This will not work in Greece because people will not want to give up their savings in euro's. How can you get people to give up a currency if they don't want to? The Germans tried and tried to get the Dutch to give up the "Old Guilder" During the occupation and they failed as it was perceived to be worth more than the German backed paper currency ..

I agree that if your Greek you wouldn't give up the Euro if the Germans where staying put and Greece was going back to the drachma, if the Greeks get expelled I think it's all over for the Euro anyway. The Germans will walk the people will demand it.

Exiting the single currency will be a nightmare, however in the current climate it runs the risk of triggering off total collapse in the financial system. Imagine the chaos that will be triggered if your holding Euro debt in a currency that's about to die. No one will want to hold PIIGS debt.

[ShedDweller]

leaving is easy.

As for creditors of Greece....tough....they made their beds, now they had better plan for the inevitable.

So in my situation .. If did the job paying my own expenses and the bill is €9000, I've paid out €4500 in expenses ..

In nine months time Greece has dropped out of the Euro and I get paid the Drachma equivalent of €4000. I really don't see how you can say I "Made my bed" in that situation .. If a deal is made in Euro's it has to be paid in Euro's.

Greece will not be able to pay it's commercial debts in any currency except euro's. No country in modern history has defaulted on that scale .. I could see Greek Lorries being impounded by German creditors in Germany.

[Peter Hun]

Well it can but. The point being I can't see how .. how could Greece drop out of the euro ?

What would be the sequence of event's ?

At 7am, they announce all Euro's in Greek banks are no converted to Drachma, all Greek Euro notes have to be exchanged at a bank. Debts etc converted at the new rate. It would flaot at some rate and promptly fall by 30%.

No chance they would ever get back in though.

[ShedDweller]

At 7am, they announce all Euro's in Greek banks are no converted to Drachma, all Greek Euro notes have to be exchanged at a bank. Debts etc converted at the new rate. It would flaot at some rate and promptly fall by 30%.

No chance they would ever get back in though.

Why would anyone change a Euro note for a Drachma note ? If Greece pulls out then Euro notes are still legal tender outside Greece. How do you get rid of the Euro if people don't to ? And what about commercial overseas debts ?

[Peter Hun]

So in my situation .. If did the job paying my own expenses and the bill is €9000, I've paid out €4500 in expenses ..

In nine months time Greece has dropped out of the Euro and I get paid the Drachma equivalent of €4000. I really don't see how you can say I "Made my bed" in that situation .. If a deal is made in Euro's it has to be paid in Euro's.

Greece will not be able to pay it's commercial debts in any currency except euro's. No country in modern history has defaulted on that scale .. I could see Greek Lorries being impounded by German creditors in Germany.

Maybe you could get Euro's, but if its no longer that country's legal tender you might have a problem demanding it. What does your contract say? If the government does something outside your customers control they you could be stuffed.

[huw]

But HOW ? This has never been done before, when it has happened before, for instance the replacement of the French Franc you have a period where the new and old currencies are both valid .. and then the old currency is phased out ..

How do you "Phase out" the Euro ? It's still legal tender .

They moved from drachma to euro, converting deposits and issuing new banknotes etc, why wouldn't they be able to go the other way? There must also be recent experience with the USSR successor states, all of who must have managed to get their own currencies going quickly.

It's not the technical aspects that would be tricky IMO, it would be the monetary aspects, preventing capital flight and bank runs ... that means secrecy and speed ... "if it were done when 'tis done, then 'twere well it were done quickly".

[Peter Hun]

Why would anyone change a Euro note for a Drachma note ? If Greece pulls out then Euro notes are still legal tender outside Greece. How do you get rid of the Euro if people don't to ? And what about commercial overseas debts ?

Commercial debts are subject to currency risk as always..

Greek printed notes may be converted and no longer legal tender outside of Greece. Then again, the government may set up the law to allow leeway - after all the figures are tiny compared to national debt

I'd demand payment in dollars or pounds and have it in the contract.

[huw]

Why would anyone change a Euro note for a Drachma note ? If Greece pulls out then Euro notes are still legal tender outside Greece. How do you get rid of the Euro if people don't to ? And what about commercial overseas debts ?

Greek notes (printed with their country code) wouldn't be legal tender, I think. At least, it's hard to see why they would be, or who would be backing them if Greece stopped doing so.

The existence of these country codes suggests that the architects of the system wanted to allow for the possibility of different notes being treated differently in some way ... makes you think.