WHAT happens when a country changes its currency, either by creating a new one to replace the existing one or when it leaves a monetary union? A good starting point is New Zealand’s switch from sterling to the NZ dollar at the end of the 1960s. That was a simple matter of redenomination and printing new notes. There was no expectation of a parity change, so contracts were simply shifted (technically, novated) into the new currency. A country following that example could, say, choose to announce that one unit of the old currency would convert in all contracts to one unit of the new. If Scotland became independent of England, it would probably do the same: issuing its own £1 notes and simply making them exchange for English notes at one for one. This is what Ireland did following independence in the 1920s. English notes continued to circulate alongside the new Irish notes. All the government then has to do is pursue policies that allow the exchange rate to hold. A recent example of this can be found in Argentina in the 1990s where they pursued a one-for-one peso to the US dollar. Novating contracts into the new currency could obviously apply to all internal contracts. Thus, for example, Greek government debt converts to the new currency. Conversion would, and this is essential, occur on both sides of the balance sheet. There would need to be clear and consistent and legally defensible rules for assets and liabilities of foreign banks in Greece and of Greek banks outside Greece. It might turn on whether these banks were branches or subsidiaries. Contracts written so that they are adjudicated in a non-Greek jurisdiction, such as London, would be exempt from this conversion; although it would of course be available should both parties consent. New notes would not need to be printed. Old notes could be franked, and new ones issued only as the old wore out. Any currency could be used internally, although as is usual the state would accept only the domestic currency in payment of debts to it, such as taxes – to the extent that they are paid in Greece. So everything is easy. The current fuss and claims that change is impossible arise either from ignorance of even recent history or a desire to believe that something one does not want is for that reason alone impossible. However, the above description assumed that no change in parity is expected because, with the New Zealand and hypothetical Scottish examples, the change is taking place in a world of pegged or stable rates. There is another, more difficult case: that no-one knows where the currency will lie, but it is expected to be weak. This situation is viable in the long run – but problems arise in the transition. There will be a flight from the currency and banks of the devaluing country. Banks will need to have liquidity restored or they will collapse, and they will lose capital as they are forced to sell assets. All this could be prevented by surprise. Set that possibility aside, and it could still be mitigated, and the move to the equilibrium solution effected more smoothly, by the sudden introduction of exchange controls within the currency zone, and with the outside world. This would be in effect an announcement that the currency zone was about to break up. Action to achieve that would have to be quick, as the controls would soon start to leak. Delay does not provide a solution. It simply increases the losses that will arise from debt default and redenomination. So the first recommendation is that if a monetary union is threatened with break up, either complete or partial, the sooner that reality is recognised the better. At the least it would minimise subsequent recriminations. The second, and final, recommendation is as follows. Learn from history. A useful precedent is when the USA left the gold standard in 1933 and resumed it in a modified form and at a new parity in 1934. In 1933, Congress and the President passed a series of acts and executive orders which suspended the gold standard except for foreign exchange transactions, revoked gold as legal tender for debts, and banned private ownership of significant amounts of gold coin. The dollar initially floated freely, but was in 1934 re-pegged to gold at a different price ($35 per ounce instead of $20.67 per ounce); it was not restored to use for domestic transactions. Much of the arrangements for all this were made during a special long bank holiday that President Roosevelt had called. We are approaching a long bank holiday – Christmas. There could scarcely be a better time than December than to plan discreetly for and then effect the break up of a monetary union. Forrest Capie is emeritus professor of economic history at Cass Business School and Geoffrey Wood is emeritus professor of economics, also at Cass Business School. The sooner that reality is recognised the better for a monetary union breakup
Tuesday 6 December 2011 7:33 pm
History reveals breaking up a currency union isn’t hard to do – but you must be fast
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