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How to Restructure the Eurozone

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May 17, 2012 – Comments (0) | RELATED TICKERS: BRK-A

Board: Berkshire Hathaway

Author: mungofitch

I see the summary as this: - they only thing that will fix it is to print money, lots of it, for a few years - it's illegal to do so, and nobody has the power to decide anyway - ergo, tough times coming

As you note, a simple Euro exit is breathtakingly difficult, and legally ambitious too. What's the interpretation of an asset in any cross border contract? For example, Greek banks would wake up with all their deposits  redenominated in new drachmas and all their liabilities still in euros, so they would all be bankrupt, with nobody able to bail them out. Same with almost all Greek firms and many Greek households. You think you've seen riots already? Fuggedaboudit.

Best method I've come up with: (just a trivially minor variant of the "omelet" model by Catherine Dobbs who had the great insight http://blogs.reuters.com/hugo-dixon/2012/04/16/can-the-euro-...) -

The ECB announces it's doing a split on some future date, say in 18 months. The exact model is a corporate spinoff, with pre-split tracking tickers and everything. - The euro will be completely discontinued, and replaced with 2 new currencies. Call them the Neuro and the Pseudo (north and south) - All euro contracts, assets, and liabilities globally including bank deposits and bonds will have 1 euro replaced by 87.31 Neurocents and  12.69 Pseudocents, or whatever split ratio is decided upon. Anyone required to pay a euro at some future date would have that obligation  turned into the requirement to pay that specific mix of the two new currencies. - 1 Euro cash can be exchanged for that fixed ratio of the combination of new currencies at any central bank branch from the date of the ratio fix indefinitely into the future. Or at least, a very long time. Because of this, the cash in people's wallets won't become worthless even though the euro will no longer formally exist as a currency. It also means no problem replacing all the banknotes and money machines; cash could still work with euros for a while as needed.

All euro bank accounts will be "closed" and replaced with two accounts in the two new currencies. If you had account 12345 with 100 euros in it,  you would wake up on split day with that account closed, and two new  accounts 12345N with 87.31 Neuros and 12345S with 12.69 Pseudos. Same with all negative balances, like credit cards. In fact the only reason for the 18 month delay is to give the banks' software programmers time to set this up.

The spinoff Pseudo will have its own central bank located somewhere sunny. The Neuro central bank would be based somewhere cold. Each central  bank would have unlimited power to print their own currency, and the  power to levy sales tax within its currency union area. It might not ever need to use that power taxation, since it has no  expenses, but taxing power is better than gold as a currency backing:  it might be needed if the central bank ever took losses on twist operations etc. If it used the power, it would only be a low rate.

Up until the day of the spinoff, the two will track one another pretty much perfectly on the spot market, but will probably have futures contracts with the Pseudo trading at a discount in anticipation of its devaluation after the day of the spinoff. Same as Conoco.

This affects everyone equally: everyone owing a euro has to come up with 12.69 Pseudocents on split day, so there will be demand for it till then. The split ratio is determined by the fraction of eurozone GDP accounted for by  whatever subset of countries decide to join it, as decided several months in advance. Much the same way that the component currencies were pegged for a while prior to the issuance of the actual euro currency notes.

General rule: After the split, it will not be lawful to denominate any contract in euros. You have to specify whatever mix of still-existing currencies you wish: Neuro, Pseudo, a mix, or Zloty if you prefer.

Exception 1: All government transactions after the split date will have to be done solely in the currency that that country has joined. e.g., Germany would use Neuros and Greece would use Pseudos for tax collection, welfare payments, and of course bond issuance. (Outstanding bonds would still be repaid with the fixed mix rule).

Exception 2: All employment contracts could continue to run under the "euro delivery" contract rules for a while, but would have a maximum term of,  say, 1-3 years after split date before they had to be renegotiated and rewritten. Each new employment contract would have to be written in the new currency of the country in question at whatever pay level employer and employee agree. Since they are new contracts, existing clauses triggered by deemed pay  cuts or constructive dismissal from pay alteration would not apply.

The interesting question is, which countries would opt to join which currency sub-unions? A cynic might suggest Germany would join the Pseudo, so that their exporters would continue to cash in from having a cheap currency.

Jim, Your Armchair Economist

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