Ignore (for now) the question of whether, or when, or should the periphery leave the euro, as part of a debt restructuring or a long process of fixing their balance of payments crisis.
We want to have another look at its legal possibility.
Focus on what it would mean for two things: the rump monetary system of the eurozone core, including the ECB’s capital, and this extremely tricky problem of what would happen to holders of peripheral debt issued in euro and demanding payment in same.
There’s an old (1998) Norton Rose briefing on both issues doing the rounds currently (tips of the hat to Cate Long and Candice Cane). It was highly hypothetical for its time given the euro hadn’t even been introduced yet. Still, one of the paper’s authors, Gilles Thieffry, went on to develop its arguments in 2005 and 2011 papers.
Before we prise out excerpts — remember there’s an ECB working paper issued in 2009 which also addresses euro exit. It argues that a) European Community law makes withdrawal impossible b) EMU exit means leaving the EU altogether.
In fact the Norton Rose paper makes point a) too. As far back as Maastricht, monetary union was acknowledged by states as ‘irreversible’. Hence the paper almost approaches euro exit as an ‘amendment’ to the relevant treaties and therefore inherently negotiated.
Tricky legal point. But anyway, the first issue that the paper said would have to be negotiated remains relevant in 2011 we think:
The withdrawing State will have contributed its initial position of the capital of the ECB. Since the national Central Bank of the withdrawing State would cease to be a member of the ESCB, plus its share of any accrued profits but net of its share of losses…
The Maastricht Treaty does not allow for the withdrawal of contributed capital or reserves from the ECB, and financial terms would require a new negotiation. Such negotiations would be complicated by a number of factors; in particular, the withdrawal of a Member State would clearly shake market confidence in the euro and would be likely to lead to extreme volatility in its external value. This could only be mitigated by (i) a retention of a portion of the contribution of the withdrawing State and/or (ii) an additional financial contribution to the ECB by participating Member States in order to support the euro. It is quite likely that the available funding within the ECB itself would be insufficient (i) to support the euro adequately and (ii) to support the creation of a new national currency by the withdrawing State. This, in turn, might render it impossible to negotiate “exit” terms without placing the entire EMU process under impossible strain…
For the departing state, there will be the costs of establishing a new national currency and the uncertainty of its external value. This uncertainty is likely to endure for a lengthy period given the need to renegotiate the monetary aspects of the Maastricht Treaty and the inevitable complexity of the transitional arrangements which would have to be put in place. The scale of the costs and liabilities involved – and the difficulty of quantifying them with any precision – must of themselves be very significant deterrents to any attempt by a participating state to negotiate a withdrawal. For those States which continue to form a part of the euro zone, the very existence of such negotiations would clearly have an adverse impact on the value of the euro and on their financial markets generally…
(The issue of re-acquiring reserves is potentially huge, considering how rapidly post-euro currencies could devalue.)
On to the second issue — re-denomination of peripheral debt when the alternative and original medium of payment, the euro, remains enforceable elsewhere.
The briefing argued these points, using the Netherlands as a hypothetical state leaving the euro:
If the bond was issued after 1st January 1999, then it will be expressed in euro and there will be no direct, contractual link to the former Dutch national currency. But if the debt is payable within the Netherlands, then it is suggested that debtor can discharge the obligation either (i) by payment in euro, since the obligation is expressed in that currency or (ii) by payment in the new Dutch currency, because the law of the place of payment may be taken into account in determining the means or method of payment. In the latter case, the appropriate rate of exchange between the euro and the new Dutch currency would be governed by the law applicable to the instrument or obligation in question – the courts would not necessarily adopt the exchange rate prescribed by the new Dutch monetary law.
If the bond was issued after 1st January 1999 but is expressed to be payable in euro outside the Netherlands, then it seems that the alteration in the Dutch currency should be irrelevant. Performance of the obligation in euro in the stipulated place of performance is entirely possible, because the euro remains the currency of the other, EMU-participant States. This rule would continue to apply even if the issuer were a Dutch-incorporated entity…
Which is really not what we’ve heard so far about re-denomination effects on peripheral debt! — generally that it would be a wasteland of altered payment terms and restructuring obligations. However it would still be a real mess of litigation.
Anyway, the paper really does emphasise how closely negotiated a peripheral sovereign’s euro exit would have to be. There’s little that suggests an ultimatum-type exit conducted overnight would work at all. (We haven’t even gone into the legality of corralito-style capital controls to stop a bank run during a euro exit, either.)
The point is though — Thieffry’s 2011 update of his ‘thinking the unthinkable’ paper was titled ‘thinking the probable‘. For better or worse, the cat is out of the bag on the conceivability of a euro exit. Hence there’s an urgent need now for a legal Plan B that can address what would happen to markets in such a scenario.
Whether or not euro exit would make economic sense for departing peripherals…that’s a different matter.
The eurozone’s journey to defaults – Martin Wolf / FT
A secessionist recession for EU peripherals? – FT Alphaville (2010)
Some intra-eurosystem inequality – FT Alphaville
EMU — How Will the Markets Price Break-up Risk? – Investment Policy (1999)