# The practicalities of Ireland leaving the Euro.



## darag (2 May 2010)

This idea has infected a number of the sub-forums with threads on the subject and I want to start a single thread about what exactly would be involved in Ireland leaving the Euro so that the same arguments don't get rehashed in multiple places.

For some reason the idea seems to have some currency (excuse the pun) in the media also; for this David McWilliams deserves some of the credit or blame.

I don't consider the idea to be a serious one because the proponents have never actually described their proposal in any detail.  Generally two completely separate government actions are being confused:

1. Creating a new currency (say New Punts) for general use in the economy.

2. General public and private debt default.

These actions are completely independent and McWilliams is being disingenuous (I assume) when he conflates them for the sake of producing dramatic column inches.  But I'm not so sure these days given the recent Brian Lucey gaff - perhaps he really doesn't see it.

The common factor when anyone proposes "Ireland leaving the Euro" is that they never actually describe the actual process.  The reason is that doing so would expose the muddled thinking behind this idea;  i.e. many of the "benefits" claimed for leaving the euro have nothing to do with what currency is in use in Ireland but would actually result from government default on its sovereign debt (which is about to happen in Greece and has happened in Iceland) combined with state theft from all the personal bank accounts, pensions, etc. in the country (like what has happened in the past in a number of South American countries) and then attempting to inflate our way to competitiveness and out of state spending deficit (like Zimbabwe) .

Obviously association with the pain of countries like Iceland, Greece, Argentina and Zimbabwe taints the idea somewhat.

So what would be involved in Ireland actually leaving the euro?

Broadly speaking, it would involve the government creating "New Punt" notes and coins in a factory somewhere and creating billions worth of Punt debt in the central bank (backed by Euro assets) for the Irish retail banks to buy.  Next, when everyone was ready, the government would simply demand that all taxes and government charges be settled in this new currency.  Practically speaking, this would force all shops to switch to the new currency and  employers to switch to paying in New Punts.  Everyone would have to open New Punt current accounts.

Existing euro accounts (savings and loans - including mortgages) would remain unaffected as would existing government debt.

The net gain for the country?  Very little in Ireland's case because of the level of public and private debt.  We could try to devalue the New Punt to gain export competitiveness but that would create a fiscal squeeze on the government as their euro debt payments would increase relative to the new currency.  The very same pain would be felt by individual mortgage holders, for example, as their monthly payments would jump every time the New Punt lost ground against the Euro.  In fact anyone earning a living in Ireland (i.e. earning New Punts) but with existing debts (in Euro) would be clobbered; this includes the state itself as well as businesses and individuals.

The inflation resulting from devaluation would also allow the government to cut spending in real terms without nominally cutting social welfare payments or public sector salaries.  This is of no REAL benefit but sometimes is seen as more politically attractive because people generally are immediately outraged with nominal cuts in what they are paid while the outrage with real cuts caused by inflation takes a while to build up.

Add to this the cost of the huge bureaucratic effort to adopt the new currency - from government departments to every business in the country, big and small.  As a globalized country (Ireland's imports and exports are huge) - currency risk would become significant again which would hit the general economy.

On this cost/benefit basis leaving the Euro looks like a completely daft idea.

However, the proponents of the idea generally magic away these costs by sneaking in sovereign debt default and government theft from savers.  In one article McWilliams claims that re-denominating existing debt from one currency to another "is commonplace in the markets".  This is simply a lie or a gaff on McWilliams' part.  In the bond markets where Ireland borrows money,  this re-denomination of debt is considered default.  This is not some subtle legal aspect of bond markets, it is very obvious; for example, if I owed you 100 Euro but then told you that instead of paying you back the Euro, I was going to pay you back in cowry shells (an ancient form of money) or in Zimbabwean dollars, then you'd consider that I had welshed on my debt.  The bond markets are the very same.

But lets play along with the idea; the government then defaults on its debts but offers to pay back some of what they owe using New Punts.  For a country that needs to borrow 20 billion a year to pay salaries to teachers, guards and nurses, for example, this would be suicide.  Irish sovereign debt yields would spite horribly meaning huge costs for new government borrowing.  The numbers might make some sense if Ireland's existing debt was huge reletive to it's new borrowing requirements but this is not the case; our existing national debt is relatively small compared to the size of the deficit which needs to be funded by new borrowing.  Thus the state would be forced to make more spending cuts OR go the Zimbabwe route and print New Punts like there was no tomorrow (massive inflation, huge interest rates, government debt payments gobbling up a huge proportion of the budget, etc.).

But government default doesn't address the pain felt by individuals and businesses where the interest payments in Euro would become intolerable to service using New Punts.  The government would have some equally unpalatable options here too; forcibly convert all domestic accounts from Euro to New Punts at a fixed exchange rate.  Effectively this would involve stealing from savers/investors to pay debtors.  This has been tried with very unpleasant results in Argentina for example.  Also such a move would require a referendum to remove the constitutional protection of individual property rights.

So while McWilliams or any of the other proponents of this vague idea of "leaving the euro" ignore all these unpalatable choices, then the idea deserves no serious consideration in my point of view.


----------



## onq (2 May 2010)

Thank you for a lucid account of the issues involved.

Painting with a big brush covers a lot of surface.

Its the details that take time to consider.

ONQ.


----------



## Duke of Marmalade (2 May 2010)

When adopting someone else's currency, as Ireland always has had to do (first England's, now Germany's) we are vulnerable on two fronts:

1) That other country's interest rates have to be suitable for us. Right now 1% ECB is exactly what we want so no complaint there.

2) We are unable to make a competitive devaluation. But again the ESRI predicts that we will have a Balance of Trade surplus this year, so again no issue.

So you are right _darag_ proponents of leaving the euro really mean debt default not a change of currency. Ironically the best course would arguably be to default on our debts and *stay* in the euro. But the ECB would not allow that, after all they would be big losers on the default and would be setting themselves up for the next default.


----------



## leesider29 (3 May 2010)

This is not some subtle legal aspect of bond markets, it is very obvious; for example, if I owed you 100 Euro but then told you that instead of paying you back the Euro, I was going to pay you back in cowry shells (an ancient form of money) or in Zimbabwean dollars, then you'd consider that I had welshed on my debt. The bond markets are the very same.


Just on what you said above, how did it work when we changed over to the euro?? was there a mechanism in place whereby our debt was transferred to euro over a number years?


----------



## jhegarty (3 May 2010)

leesider29 said:


> Just on what you said above, how did it work when we changed over to the euro?? was there a mechanism in place whereby our debt was transferred to euro over a number years?



There was a fixed exchange rate , so it could be done overnight.

The issue is that a new currency could not be fixed to the euro.


----------



## Duke of Marmalade (3 May 2010)

leesider29 said:


> Just on what you said above, how did it work when we changed over to the euro??


It's a good question which bears reflection. Technically a country *can* change its currency e.g. Marks to New Marks, Francs to New Francs, Punts to Euro etc.

So let's say we want to change to _paddybacks_. On P-day the law would state that all existing contracts denominated in euros will henceforth be interpreted as denominated 1 for 1 in _paddybacks_. So mortgages, salaries, shop prices etc. stay the same, just they are now in _paddybacks_. 

As yet nothing has changed but presumably the trick would be that on P-day + 1 the CB would announce an exchange rate of 2 _paddybacks_ to the euro. Risky, risky move - now all euro debt established under foreign law, and all sterling, dollar etc. debt (even if under Irish law) has been doubled relative to our GNP. The gamble is that the competitive boost to our exports would hugely expand the economy, closing the fiscal imbalance and doubling our GNP to cancel out the effect just mentioned.

Of course this is all a nonsense, why am I even entertaining it? For a start everybody including myself would have moved their euro deposits well off shore in advance of P-day. The move would have to be accompanied by a confiscation tax of 50% of all foreign deposits opened since the announcement of P-day.

_(Of course this is completely different from arguing that we should never have been in euro in the first place and that we would have more flexibility with our own currency.)_

There has never, ever been a situation where a country has launched a new currency with the clear intention of immediately devaluing it. All changes in currency have been well intentioned attempts to try and launch a new currency more robust than the last, they are meant to be confidence boosters. Thus getting back to the quoted question most people accepted that the upcoming change to euro would strengthen their monetary assets and there was no rush for the sterling or dollar exits. 

[broken link removed]is utter nonsense. Is it a gaff of Lucey proportions? I think it is simply self serving egotistical rubbish, all that stuff about how prophets like him are initially spurned by the conventional wisdom but eventually they are proved right. If in any way McWilliams actually believes this then it is worse than the Lucey Gaff, as I think that the prof now acknowledges that he got his assets mixed up with his liabilities.

The frightening thing is that our garlic chewing MoF went to McWilliams for advice.


----------



## darag (3 May 2010)

jhegarty said:


> There was a fixed exchange rate , so it could be done overnight.


Correct, but it doesn't even have to be done overnight as long as they've been locked together in a fixed relationship/exchange rate.  Remember for years after the switch-over you could still bring your old fivers and tenners to the bank and have them exchanged for Euro?

More more importantly, the old pounds and pennies had no real use after the switch over; you couldn't buy stuff with them, you couldn't invest them, you couldn't pay your taxes with them.

Ignoring the fact that it would be completely pointless to introduce New Punts only to maintain a fixed exchange rate against the Euro; if if this was the stated intention,  who would really trust the government long term to maintain their promise?

If they even tried this tack, they'd get nowhere.  The "old" currency (Euro) would not become useless the way the Punt did when the Euro came in.  Yes, New Punts would be needed for salaries and shopping and taxes but savings and investments would be a completely different matter.  Individuals and corporations would transfer all their savings into Euro accounts in other EU countries as fast as they could while the government attempted to honour its commitment that New Punts were fixed against the Euro.  The resulting flight of capital out of the country would cause an economic shock which would make the current credit contraction look like a picnic. 

No, Duke is right, it's silly to even entertain the idea.  There are no permutations or combinations where it could make the slightest bit of sense.  And at worse it would cause economic Armageddon.


----------



## ibaraki (4 May 2010)

Duke of Marmalade: 'All changes in currency have been well intentioned attempts to try and launch a new currency more robust than the last, they are meant to be confidence boosters'

Following this logic, could Germany leave the Euro?


----------



## Duke of Marmalade (4 May 2010)

ibaraki said:


> Duke of Marmalade: 'All changes in currency have been well intentioned attempts to try and launch a new currency more robust than the last, they are meant to be confidence boosters'
> 
> Following this logic, could Germany leave the Euro?


It could of course.  Germany obviously sees big political benefits as well as the benefits of a wider single currency trading zone but I would suspect most Germans think they are propping up the euro.  It wouldnt happen by way of Germany leaving the euro, it would happen by Germany throwing all the PIIGS out.


----------



## UptheDeise (4 May 2010)

Why won't the ECB (Germans) devalue the euro? Is it because it would lead to inflation?


----------



## shanegl (4 May 2010)

The last people who would want to see devaluation (aka theft of savings) of the Euro are a nation of savers.


----------



## Duke of Marmalade (4 May 2010)

UptheDeise said:


> Why won't the ECB (Germans) devalue the euro? Is it because it would lead to inflation?


The euro is a floating currency, its exchange rate is not decided by governments or central banks.


----------



## Strathspey (5 May 2010)

I think the ECB has quite successfully managed a devaluaton of the Euro by at least 10% because of the Greek crisis.


----------



## Chris (6 May 2010)

shanegl said:


> The last people who would want to see devaluation (aka theft of savings) of the Euro are a nation of savers.


Exactly to the point, Germany wants a strong stable currency, which is one of the reasons 86% of Germans are against a Greek bailout.




Duke of Marmalade said:


> The euro is a floating currency, its exchange rate is not decided by governments or central banks.


True, but central banks have huge influence, and can actively devalue the currency by turning on the printing press.

I agree that McWilliams over-simplified the process ov leaving the Euro; it took years to introduce the Euro in the first place. But even given the obstacles to leaving the Euro, I believe it will turn out to be the lesser of two evils. Soveraign debt in the western world is out of control, and will ultimately lead to the collapse of currencies, including Euro, Sterling USD.
The biggest flaw in McWilliams solution is not that he is suggesting an indirect default through currency devaluation, but that he is suggesting to replace one fiat currency with another. That's like telling an alcoholic to switch to heroin as solution to his problem.


----------



## csirl (6 May 2010)

In the current economic climate, there is little tolerance for a small independent currency such as the punt. It would be virtually worthless in no time at all.


----------



## Duke of Marmalade (6 May 2010)

chris said:


> but even given the obstacles to leaving the euro, i believe it will turn out to be the lesser of two evils.


I don't understand this point. What is the other evil which leaving the euro spares us from?



			
				david mcwilliams said:
			
		

> what can we do about this? The obvious answer is to leave the euro, reinstitute our own currency, allow it to plummet to reflect the real competitive position of our ruined, feeble economy and start again.


 
It is not just that this is hopelessly impractical or that people will jump ship long before the changeover, thus defeating its purpose. Even if this could be done overnight it doesn't bear scrutiny. Picture the scenario, you wake up, look at your online bank statement - it states your balance, same as yesterday, but what's this funny _paddybacks_? You find that your mortgage has been restated in _paddybacks_, your salary, all shop prices. Naturally you enquire what these are worth and you are told they are worth 50 euro cent. The David McWilliams silver bullet has been delivered. Note that few have really gained. People with mortgages may think they owe half what they used to owe but then their income has been halved. 

The winners are those with foreign currency assets - euros abroad, sterling, dollars etc. The losers are those with foreign liabilities including euro loans abroad. But we are acutely aware that Ireland inc., its banking system and its government, are hugely net foreign borrowers. We would thus have disasterously increased our debt/GNP ratio. Consider a bank which has been borrowing heavily abroad to fund domestic mortgages. It is instantly insolvent. True, domestic liabilities have been halved in exchange rate terms but so too has the tax base of the Government or the income base of the banks. They can only pray that the induced competitiveness on foreign markets will translate to a big reflation of the economy, which, after all, is the only possible gain from this mad proposal.

Devaluations of your currency only help your balance sheet if you are net debtors in your *own* currency. But banks and government are net creditors in Irish based euros.


----------



## ringledman (6 May 2010)

Why do people think Ireland will pull out? Impossible. 

The only option that is good for the euro zone would be for Germany to pull out. As the deutchmark II rises in value the euro will plummet. Otherwise any nation that pulls out will see their debt load increase massively as their new currency plummets vis a vis their debt that would still be priced in euros. Repaying would be impossible.

The German electorate won't tolerate other nations living beyond their means forever. Why be the only real producing & high savings nation of the zone? Do everything right and get screwed...

ECB is going to have to start printing on the scale of the US and UK. Euro value heading down...


----------



## Duke of Marmalade (6 May 2010)

Excellent point _Ringled;_ that works. Let's hope Merkel does not subscribe to AAM, I like my euro deposits and income backed by Germany.


----------



## Chris (7 May 2010)

Duke of Marmalade said:


> I don't understand this point. What is the other evil which leaving the euro spares us from?



Appologies, indeed this comment does not make any sense in isolation. What I mean by lesser of two evils is the following. Leaving the Euro now in an organised manner and replacing an I-Owe-You-Nothing fiat currency with a commodity backed currency would not be an easy undertaking and would cause a lot of disruptions in the short term. The alternative is being part of a collapsing currency or being told to leave the Euro; this would be a chaotic and uncontrolled situation. Leaving the Euro by choice would be better than being forced out by other members or the market.

Defaulting on or restructuring of sovereign debt throughout the western world is going to become commonplace, as the debts mounted up are impossible to repay. This is becoming evident in Greece and it is going to be no different for Ireland, Portugal, UK, US, etc. It just so happens that the financially incompetent Euro members are coming under attack first.


----------

