catherine dobbs - newney approach to unscrambling the euro

7/27/2019 Catherine Dobbs - NEWNEY Approach to Unscrambling the Euro

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Contents

1. The threat to the global economy ..................................................................................... 7

Very different economies in the eurozone 7

This time might be different: a bigger shock than Lehman 13

The need for a Plan B 17

Yolk and White countries 18

Possible endgames for the eurozone 18

2. Achieving an orderly exit through the NEWNEY approach............................................. 25

Assessing different approaches to the exit of one or more states from the Euro 25

The impracticalities of a surprise redenomination 28

The NEWNEY approach in concept 31

Key steps in the NEWNEY process 36

3. Specific details on the NEWNEY approach .................................................................... 39

Setting the exchange ratio 40

Allowing FX movements and getting the exchange to happen in practice 45

Different monetary policies 49

Implications for private savings, domestic mortgages and international contracts 51

Implications for government debt 52

The stability of the banking system 54

The NEWNEY with more than 2 regions 55

Applying NEWNEY with a phased exit or with a small initial exit 55

4. Winnings and losers, and the politics. ............................................................................... 58

Evaluating winners and losers 58

The politics 61

Conclusions ........................................................................................................................... 65

Biography, contact details and acknowledgements .............................................................. 67


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This paper in no way forecasts that any country will, or should leave the eurozone. It was written to

contribute one idea to a debate on possible options should a country decide to leave.


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Many have used the omelette analogy. For instance, Wolfsons prize is impossible to win by TimHarford, Undercover Economist October 21, 2011 Financial Times

If you approach this as a fried egg analogy, you end up thinking of the core countries as the Yolk andthe periphery countries as the White. However, as Tim Hartford (ibid) has pointed out, the Euro is moreof an omelet than a fried egg. Its the sunny yolk countries that have too much cholesterol (debt) butmaybe for some are a bit more yummy. The White countries are snowy, and some believe that we needto move to more of a lower cholesterol egg white omelet. For a detailed nutritionist discussion, seeHugo Dixons Reuters BreakingViews:http://www.reuters.com/video/2012/04/16/reuters-tv-breakingviews-can-the-euro-omelette-be-

u?videoId=233383502&videoChannel=117766


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A number of others have described approaches with some similarities to NEWNEY. These include: I'mclaiming the 250,000 Wolfson prize for how to break-up the Euroby Jeremy Warner, Daily Telegraph 6January 2012. Why we must break up a failing Euro by Martin Jacomb, Financial Times May 23 2012.Olaf L. Mueller: "Eine Zentrifuge fuer den Euro". Neue Zuercher Zeitung NZZ No. 37 (February 14th,

2012), p. 19.


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Very different economies in the eurozone


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CHART 1

Sources: Oanda; OECD

While the Euro notes and coins were not introduced until January 2002, two years later, the exchangerates between countries were locked on the 31 December 1998.

Wage data from OECD dataset.


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CHART 2

Sources: ECB Statistics Pocket Book

Debt data from The McKinsey Global Institute Debt and Deleveragingreports

Source: European Central Bank, Statistic Pocket Book, January 2012.


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See The euro: love it of leave it?By Barry Eichengreen, VOX 4 May 2010.


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See The Euro's Trade Effects, Richard E. Baldwin (2006) Tracking Consumers Through Europes Debt Crisis by Ivan Bascle, Camille Egloff, and Catherine

Roche, BCG May 17, 2012

Authors estimate.


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Interview with Robert Peston on The Great Euro Crash. BBC


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CHART 3

Note: The Intrade volumes are relatively thin in this market.SOURCE: www.intrade.com

This time might be different: a bigger shock than Lehman


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For instance see A Primer on the Euro Breakup: Default, Exit and Devaluation as the Optimal Solutionby Jonathan Tepper, Wolfson Economics Prize entry, April 2012. Available from policyexchange.org.uk

The calculations are very approximate and draw data from Paul Bairochs Europe's Gross NationalProduct: 18001975; the IMF; and Angus Maddisons Contours of the World Economy, 12030 AD.Essays in Macro-Economic History;and the IMFs Report for Selected Countries and Subjects.

We have been unable to find country specific numbers so are using global numbers as an estimate.

Numbers are from Angus Maddsions Growth and Interaction in the World Economy.


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CHART 4

Sources: Data from McKinsey Global Institute; national sources; Lehman Brothers 10Q filings May 2008; author analysis

1 The comparison is made to illustrate the scale of the shock but is not an exact like for like comparison. Not all of Lehmans assets were exposed tobankruptcy because of netting, and not all of the countries cross border debt will be exposed to redenomination as there might be matching assets. Theanalysis assumes approximately 30% of total debt as of Q2 2011 is held cross-border for Greece, Ireland, Italy, Portugal and Spain and that 90 days ofannual export and import contracts are at risk before contracts are renegotiated. The 30% cross border assumption is based on EBAs estimate thataround 30% of Greek sovereign debt and interbank lending is held by overseas banks, and around 40% of sovereign debt for Ireland and Portugal.Detailed cross-border debt data is ge nerally not available. These are the authors assumptions for this comparison. You can m ake your own but themessage remains similar with most assumptions.

2 As of May 2008, Lehman Brothers had $639.4 billion of assets, $613.2 billion of liabilities and $26.3 billion of equity.

8x

Data from McKinsey Global Institute, Mapping the Global Capital Markets 2011.


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European banking authority, 2011 EU-wide stress test, aggregate report


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The need for a Plan B


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Yolk and White countries

Possible endgames for the eurozone


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: Euro Benefits Germany More Than Others in Zoneby Floyd Norris, New York Times, April 22, 2011;Germany and the Benefits of the Euro by Antonio Fatas; Germany cashes in on Euro benefits, for now

by Annika Breidthardt, Reuters.


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For a discussion, see Euro bonds wont cure what ails Europe, by Kotz, Krahnen and Leuz. Note this analysis was done for the EU and not the eurozone. Fiscal federalism in crisis: lessons for

Europe from the USby Zsolt Darvas, Bruegel Policy Contribution, July 2010


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CHART 5

Note: CEE10: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, andSlovenia; MED5: Cyprus, Greece, Malta, Spain, and Portugal; UK&IE: Ireland and the United Kingdom;NORD3: Denmark, Finland, and Sweden; ABLN4: Austria, Belgium, Luxembourg, and the Netherlands; Italy(IT), France (FR) and Germany (DE) are shown separately; Gradients of lines are -0.002 and -0.002.

SOURCE: Fiscal federalism in crisis: lessons for Europe from the US by by Zsolt Darvas

Euro Isnt Loved, but Few Want to Drop It, Poll Says by Paul Geitner, New York Times, reporting the

Pew Reseach Centres Global Attitude Project.


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See appendix Leaving the Euro: A practical guide by Roger Bootle and Mark Pragnell, WolfsonEconomics Prize entry, April 2012. Available from policyexchange.org.uk

See Jens Nordvig and Neil Records Wolfson Economics Prize entries, April 2012. Available frompolicyexchange.org.uk

A permanent precedentby Martin Wolf, Financial Times, May 17, 2012


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GDP per capita for Southern European countries is forecast by the EIU to not reach its pre crisis leveluntil at least 2018.

For a discussion see Unemployment Scarringby Wiji Arulampalam, Paul Gregg and Mary Gregory, The

Economic Journal


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Assessing different approaches to the exit of one or more states from theEuro


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CHART 6

Sources: BIS

Note: excludes the impact of corporate and bank debt1 Based on BIS data as of Q2 2011. We have not factored in complications of domestic cross-funding and inter-linked obligations for this

illustrative comparison

European Banking Authority, 2011 EU-wide stress test, aggregate report


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Billionaire who broke the Bank of England, By David Litterick, Daily Telegraph, 13 Sep 2002 This point has been made by Nobel economics laureate Christopher Pissarides in Euro Exit Would Cost

Poor Greeks, reported by Jennifer Ryan in Bloomberg Businessweek


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The impracticalities of a surprise redenomination


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The approach to stamping notes, has been suggested by Eric Dor in Leaving the Euro Zone: a usersguide published in October 2011. The approach is similar to that used in the dissolution of othercurrency regimes such as Czechoslovakia see Teppers A primer on the Euro Breakup, Wolfson

Economics Prize entry, April 2012. Available from policyexchange.org.uk.


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See Greece should leave the Euro. How do you do that? by Jurre Hermans. Wolfson Economics Prize

entry, April 2012. Available from policyexchange.org.uk


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The NEWNEY approach in concept


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For details on automatic wage indexation see Figure 7 Leaving the Euro: A practical guide by RogerBootle and Mark Pragnell, Wolfson Economics Prize entry, April 2012. Available from

policyexchange.org.uk


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CHART 7

6050403020100

Source: This Time is Different: A Panaromic View of Eight Centuries of Financial Crises, by Reinhart and Rogoff

Thanks to Hugo Dixon for pointing out the need to clarify this point explicitly.


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How the exchange ratio and market exchange rate can beused to determine the value of a Euro in a contract

Exchange ratio set attransition

1 Euro = 0.7 NEW (neweuro-white)

+ 0.3 NEY(new euro-yolk).


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Key steps in the NEWNEY process

1.

2.


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3.

4.

5.

6.

7.


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8.

9.


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3. Specific details on the NEWNEYapproach

CHART 9

Illustrative data for Yolk zone exiting the eurozone

EUR BILLIONS

Eur Billions % eurozone

GDP 1,800 20%

Money supply 1,850 20%

Real economy debt 6,600 22%


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Setting the exchange ratio

CHART 10

Belgian Franc 40.3399

Luxembourg Franc 40.3399

Deutsche Mark 1.95583

French Franc 6.55957

Dutch Guilder 2.20371

Austrian Shilling 13.7603

Irish Punt 0.78756

Portuguese Escudo 200.482

Spanish Peseta 166.386

Italian Lira 1936.27 Finnish Markka 5.94573

Source: European Central Bank


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"Did Prices Really Soar after the Euro Cash Changeover? Evidence from ATM Withdrawals". PaoloAngelini; Francesco Lippi;. Fnf Jahre nach der Euro-Bargeldeinfhrung War der Euro wirklich einTeuro? [Five years after the introduction of Euro cash Did the Euro really make things moreexpensive?] Irmtraud Beuerlein; Did the introduction of the Euro impact on inflation uncertainty? - An

empirical assessment, Matthias Hartmann and Helmut Herwartz; source Wikipedia


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CHART 11

EUR BILLIONSPre Separation Post Separation

Euro Zone White Zone Yolk Zone Comment

Currency incirculation

847 886 141 Need to adjust forreserve currencystatus remaining inthe White Zone andfrictional effect

Overnight deposits 3,942 3,154 788 Pro rated by GDPand GDP multiplier

Deposits with anagreed maturity ofup to 2 years anddepositsredeemable atnotice of up to threemonths

3,801 3,041 760 Pro rated by GDPand GDP multiplier

Money market funds 1,185 948 237 Pro rated by GDPand GDP multiplier

Real Economy Debt 30,000 23,400 6,600 Higher debt levels inYolk Zone

Less double

counting as held byfinancial institutions

- 20,000 - 16,400 - 3,600 Higher bank holdings

in White Zone

Total 19,775 15,028 4,927

Exchange ratio 0.75 0.25


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ECB Statistics Pocket Book, January 2012


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CHART 12

Sources: Eurostat; national sources;

Allowing FX movements and getting the exchange to happen in practice


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CHART 13

EUR BILLIONS

Pre Separation Post Separation

Euro Zone White Zone Yolk Zone

Money supply and net debt 15,028 4,927

Money Created NEWs 11,318 3,710

NEYs 3,710 1,217


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Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2010, Bankfor International Settlement.

See for instance, The controversial benefits of opting outFinancial Times December 1, 2005


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CHART 14

Sources: Bloomberg; Eurostat

Different monetary policies

A rise in interest rates can result in a currency increasing in value on a one off basis as capital isattracted in. But these higher interest rate will have been announced before separation. The forwardcurve for the currency would include an expected depreciation in the currency reflecting the interest rate

differential.


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CHART 15

Sources: Datastream, World Bank DEC Prospects Group;


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Implications for private savings, domestic mortgages and internationalcontracts

CHART 16

Sources: McKinsey Global Institute

67

87

124

105

98

48

45

62

82

94

60

81

91

0 10 20 30 40 50 60 70 80 90 100 110 120 130


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Implications for government debt


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CHART 17

Sources: McKinsey Global Institute

Reinhart and Rogoff's This Time is Different


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CHART 18

1 Sample size includes all countries, out of a total of sixty six, that were independent states in the given year

Sources: Lindert and Morton (1989), Macdonald (2003), Purcell and Kaufman (1993), Reinhart, Rogoff, and Savastano(2003), Suter (1992), and Standard and Poors (various years)

The stability of the banking system


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The NEWNEY with more than 2 regions

Applying NEWNEY with a phased exit or with a small initial exit

Nervous Europeans Snap Up London Property by Andrew Testa, The International Herald Tribune;

Foreign interest boosts prime locations, by Tanya Powley


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A variety of the parallel currency has idea has been discussed by Gavyn Davies (FT May 24); TomasMayer (Deutche Bank); and Huw Pill (Goldman Sachs). However, these cases all have Greece

remaining in the Euro. With the NEWNEY-lite this would not be the case eventually.


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Evaluating winners and losers

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Illustrative data for Yolk zone exiting the eurozone

DOLLAR BILLIONS

GDP 2,000

Overseas country liabilities, of which:*

ECB (LTRO, ELA, etc)

Target 2

Government debt help overseas

Loans from the IMF

1,800

400

500

800

100

* Some will be via the central bank.


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The politics


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Time to plan an velvet divorceby Gideon Rachman, Financial Times.


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Catherine Dobbs

Acknowledgements


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catherine dobbs - newney approach to unscrambling the euro

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