There have been several populist and technical arguments in favour of exiting the euro, put forward over the past few years as the Eurocrisis has dragged on. But what are the real, political and economic costs involved? What’s the price of leaving the eurozone?
by François Bares
The French Front National (FN) and its leader Marine Le Pen has been recurrently advocating an exit from the eurozone, much like Beppe Grillo and the Movimento 5 Stelle (M5S) have in Italy. In fact, eurosceptic party regularly take shots at the European Economic & Monetary Union (EMU). Criticisms can also be found among dissenting voices in mainstream parties and usually centre around the idea that ‘one size fits all’ has failed, proved by the Eurocrisis.
Whilst much of the debate regarding EMU membership has either been normative – dealing with matters of identity and sovereignty – or technical – the economic rationale, often framed by ‘Optimum Currency Area’ (OCA) theories – little has been said about how, practically, an EMU member-state could break away and restore its old, national currency, and what would be the direct short term consequences?
If tomorrow France decided to leave the euro and reintroduce the franc, it will have to settle on a starting exchange rate between the euro and the franc, for example, the rate that was existed prior to the changeover in 2002. Regardless of the initial rate, one can expect that the value of the franc to fall; whether through an intentional government-led devaluation or through market forces, it is safe to assume that the new franc will trade for much less than a euro, looking at history and the current position of the French economy.
Thereafter, France will have to re-denominate all debts, assets, money, or any other kind of contractual commitment in francs, provided that those are under French Jurisdiction. The latter is true for external French sovereign debt, which would be devalued, constituting a partial default of France on its external debt. This in turn could increase the risk premium on French sovereign bonds and hence increase the financing cost of the sovereign debt.
Unlike sovereign debt, external private liabilities and assets do not necessarily fall under French jurisdiction and it is likely that they will retain their previous denomination. Subsequently, domestic banks and firms will suffer from the sudden rise in the value of their external liabilities relative to their domestic income and assets, now in francs. Reversely, entities that possess more foreign assets than domestic liabilities will benefit from a relative increase in capital. To mitigate the process, FN has proposed and exceptional tax on foreign assets held by domestic banks.
The breakup of Czechoslovakia neatly shows the impact of such a process, as thousands of Slovak importers tried to pay their debts off in anticipation of a devalued Slovak currency – the Czechs did the opposite. This led to a gradual outflow of capital from Slovakia to Czechia; in our case, this might compel the French government to introduce tight capital controls to limit any outflows.
All bank deposits in French banks would be changed into francs. This could prove contentious, especially for the accounts held by non-residents. Similarly, accounts held by French citizens in foreign banks will probably remain unchanged, causing some issues of fairness in the process. Anticipating the changeover, account holders will be tempted to send their money to other eurozone member-states to preserve the value of their savings. This phenomenon, on a large scale, could provoke bank runs and might force the government to freeze bank deposits during the transition period.
All other commercial or financial contracts, such as labour contracts, pensions or mortgages, if they involve foreign stakeholders, will be treated case by case according to which jurisdiction they fall under, and might involve intergovernmental agreements. Many cases will be generated which are even more complicated, for example contracts or transactions denominated in euros but undertaken outside the eurozone.
The Banque de France would once again be placed in charge of the French monetary system. The introduction of the physical currency and the replacement of old euro notes will probably take time. During the transitional period in between, one can expect a similar situation than between 1999 and 2002 when the euro was introduced but not its coins and notes. On 1 Jan 1999, national currency banknotes became ‘fractional denominations’ of the euro. By the same token euros, or perhaps only French euros, euro banknotes could be used as legal tender in France.
From an individual perspective, some parts of the population could be strongly affected by the changeover. People that have the value of their home denominated in the national currency and their mortgage issued overseas or vice versa might incur a dramatic loss or gain accordingly. Such cases would likely be marginal. More common would be the issue of pensioners who live overseas and could suffer from the mismatch between a devalued pension and constant living expenses.
Ultimately, the reintroduction of a – presumably – weaker Franc will be a progressive and contentious process which will create both winners and losers. These disparities might be mitigated by lump sum transfers from the winners to the losers – or they might not be.
Furthermore, these are only the domestic implications of leaving the euro; the international political repercussions that such move could have are just as important and potentially mixed. Finally, this analysis relies on the assumption that, upon a French exit, the euro would still exist. Realistically, a French exit would probably trigger the collapse of the euro altogether. In this case, the situation would be much more chaotic and the consequences on individuals will mostly depend on the values of all the newly forms currency relative to each other.1989 Generation