Debt Restructuring & Eurozone Exit Irelands Escape from Permanent Economic Crisis Cormac Lucey

PROPOSITION 1: EUROZONE MEMBERSHIP CAUSED A MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

Eurozone interest rates too low for Peripherals
Eurozone interest rates too high for Peripherals

Cross of Euros Kevin ORourke & Alan Taylor, Journal of Economic Perspectives, Summer 2013

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

ECONOMIC GROWTH SURPASSES FORECASTS

INAPPROPRIATELY LOW INTEREST RATES + LOW DEBT LEVELS

PROPERTY PRICES UP

AMPLIFIED BY INTERNAL REVALUATION EFFECT / REER UP

LARGE TAX CUTS AND SPENDING INCREASES

EMPLOYMENT NOS AND PAY RATES UP

INFLATIONARY CREDIT BOOM

IMPROVED PUBLIC FINANCES

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

ECONOMIC GROWTH UNDERSHOOTS FORECASTS

INAPPROPRIATELY HIGH INTEREST RATES + HUGE DEBT LEVELS

PROPERTY PRICES DOWN

AMPLIFIED BY INTERNAL DEVALUATION EFFECT / REER DOWN

LARGE TAX INCREASES AND PUBLIC SPENDING CUTS

EMPLOYMENT NOS DOWN

DEFLATIONARY CREDIT BUST

PUBLIC FINANCES IN CRISIS

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

Monetary Policy, Market Excesses and Financial Turmoil Rudiger Ahrend, Boris Cournde and Robert Price, OECD Economics Department Working Paper No 597, March 2008 10

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

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MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

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MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

Irish ULCs still need to drop 22% to recover 1994 relationship with German ULCs

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

MONETARY POLICY INDUCED DEBT AND REAL EXCHANGE RATE CRISIS

He [Churchill] was just asking for trouble. For he was committing himself to force down money-wages and all money-values, without any idea how it was to be done. Why did he do such a silly thing? Partly, perhaps, because he has no instinctive judgment to prevent him from making mistakes; partly because, lacking this instinctive judgment, he was deafened by the clamorous voices of conventional finance; and, most of all, because he was gravely misled by his experts.
- John Maynard Keynes, The Economic Consequences of Mr Churchill, 1925

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PROPOSITION 2: PLAN A CANT WORK AND ISNT WORKING

PLAN A CANT WORK

as it Addresses Symptoms and Not Causes Focus on
Banking union to fix banks Employment initiatives to fix unemployment Austerity to fix public finances, Part I Fiscal union to fix public finances, Part II

No focus on
Interest rates Monetary policy Exchange rates Fallacy of composition

Even if the authorities were successful in eliminating all the EZ imbalances which have built up since 1997, the fundamental flaw of inappropriate monetary policy would remain. Similar imbalances would build up in a similar way in the future.

PLAN A ISNT WORKING

- IMF, Euro Area Policies Article IV Consultation, July 2013

PLAN A ISNT WORKING

PROPOSITION 3: PLAN B IS A MONETARY POLICY/EXCHANGE RATE/DEBT RESTRUCTURING SOLUTION

PLAN B: EUROZONE EXIT / DEBT RESTRUCTURING

Sovereign default often triggers a bank run, capital flight and devaluation as companies and individuals try to minimise their losses. And finally, there are often political costs of default for the government of the day. This political cost of default raises the possibility that politicians may hang on, servicing public debt beyond the date at which it makes sense for the country as a whole.
- Why do countries default and what are the consequences? Capital Economics, July 2011.

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PLAN B: EUROZONE EXIT / DEBT RESTRUCTURING

Many economists expect catastrophic consequences if any country exits the euro. However, during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises.
- A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solution, Variant Perception, February 2012.

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PLAN B: EUROZONE EXIT / DEBT RESTRUCTURING

Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable. Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).
- A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solution, Variant Perception, February 2012.

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PROPOSITION 4: THE BROAD DETAILS OF PLAN B ARE CLEAR

THE BROAD DETAILS OF PLAN B ARE CLEAR

We recommend the following steps: 1. Convene a special session of Parliament on a Saturday, passing a law governing all the particular details of exit: currency stamping, demonetization of old notes, capital controls, redenomination of debts, etc. These new provisions would all take effect over the weekend. 2. Create a new currency (ideally named after the preeuro currency) that would become legal tender, and all money, deposits and debts within the borders of the country would be re-denominated into the new currency. This could be done, for example, at a 1:1 basis, e.g. 1 euro = 1 new drachma. All debts or deposits held by locals outside of the borders would not be subject to the law. 3. Make the national central bank solely charged, as before the introduction of the euro, with all monetary policy, payments systems, reserve management, etc.
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THE BROAD DETAILS OF PLAN B ARE CLEAR

4. Impose capital controls immediately over the weekend. Electronic transfers of old euros in the country would be prevented from being transferred to euro accounts outside the country. 5. Declare a public bank holiday of a day or two to allow banks to stamp all their notes, prevent withdrawals of euros from banks and allow banks to make any necessary changes to their electronic payment systems. 6. Institute an immediate massive operation to stamp with ink or affix physical stamps to existing euro notes. Currency offices specifically tasked with this job would need to be set up around the exiting country.

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THE BROAD DETAILS OF PLAN B ARE CLEAR

7. Print new notes as quickly as possible in order to exchange them for old notes. Once enough new notes have been printed and exchanged, the old stamped notes would cease to be legal tender and would be demonetized. 8. Allow the new currency to trade freely on foreign exchange markets and would float. This would contribute to the devaluation and regaining of lost competitiveness. This might lead towards a large devaluation, but the devaluation itself would be helpful to provide a strong stimulus to the economy by making it competitive. 9. Expedited bankruptcy proceedings should be instituted and greater resources should be given to bankruptcy courts to deal with a spike in bankruptcies that would inevitably follow any currency exit.

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THE BROAD DETAILS OF PLAN B ARE CLEAR

10. Begin negotiations to re-structure and re-schedule sovereign debt subject to collective bargaining with the IMF and the Paris Club. 11. Notify the ECB and global central banks so they could put in place liquidity safety nets. 12. Begin post-facto negotiations with the ECB in order to determine how assets and liabilities should be resolved. The best solution is likely simply default and a reduction of existing liabilities in whole or in part.

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THE BROAD DETAILS OF PLAN B ARE CLEAR

13. Institute labour market reforms in order to make them more flexible and de-link wages from inflation and tie them to productivity. Inflation will be an inevitable consequence of devaluation. In order to avoid sustained higher rates of inflation, the country should accompany the devaluation with long term, structural reforms. Greece and Portugal should definitely exit the euro. Ireland, Spain and Italy should strongly consider it.
- A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solution, Variant Perception, February 2012.

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PROPOSITION 5: PLAN B HAS HIGH UP-FRONT COSTS AND COULD TRIGGER SIGNIFICANT COLLATERAL DAMAGE

PLAN B HAS HIGH UP-FRONT COSTS

Likely Winners Those who funded foreign investments with domestic borrowings Manufacturers Likely Losers

Plus government creditors i.e. bond-holders + EU/ECB/IMF Troika.

Those who funded domestic investments with foreign borrowings Bankers

Borrowers
Exporters Domestic tourism sector

Depositors
Importers Package holiday companies

Agriculture
Young entrants to workforce Those governing in 2-3 years

Public sector
Retirees Those governing now
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PLAN B COULD TRIGGER HIGH COLLATERAL DAMAGE

U.S. Treasury Secretary Timothy F. Geithner pressed European policy makers to intensify their efforts to end the 18-month sovereign debt crisis and avoid the threat of cascading default, bank runs and catastrophic risk.
Sept. 24 2011 (Bloomberg)

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PROPOSITION 6: ANY DECISION TO OPT FOR PLAN B WILL COME DOWN TO POLITICS

ANY DECISION TO OPT FOR PLAN B WILL COME DOWN TO POLITICS

Nature of EZ exit decision (high and definite upfront costs with hard to quantify medium-term benefits) makes it a neuralgic option for politicians unless they are at start of a government term. The moment of truth may arrive if another country Spain, Italy, Cyprus? - leaves and financial markets put pressure on other Eurozone peripherals for an immediate in/out decision . Look, theres a point at which courage turns into stupidity. And we fought the good fight. Theres no point in us fighting a battle thats going to destroy us.
- Maurice Doyle, January 1993, quoted in David J. J. Lynchs When the Luck of the Irish Ran Out

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SIX PROPOSITIONS
1. Eurozone membership caused a monetary

2. 3. 4. 5. 6.

policy induced debt and real exchange rate crisis. Plan A cant work and isnt working. Plan B is a monetary policy / exchange rate solution allied to debt restructuring. The broad details of Plan B are clear. Plan B has high upfront costs and could trigger significant collateral damage. Any decision to opt for Plan B will come down to politics.