EXITING THE EURO? Mark Weisbrot, Hans Werner Sinn and Nuriel Roubini versus the eurozone’s Eagles’ Doctrine

Thankfully, last Friday’s Der Spiegel article (as I had imagined it would [1]) opened a Pandora’s box of views on the state of the eurozone. Why thankfully? Because, until now, Europe has been living in denial, imagining that the crisis could be dealt with by a mix of expensive loans, deep austerity and tighter fiscal discipline. It is now clear that this mix only accelerates the crisis and multiplies its eventual cost. A new tack is, therefore, of the essence.

Recalling that the ball started rolling when Der Spiegel inaccurately reported that Greece was contemplating a heroic exit from the euro, the past few days saw a candid debate on the pros and cons of such an exit. Mark Weisbrot weighed in with a piece in the New York Times entitled Why Greece should reject the euro. While his take on the impossible situation that Greece is now in is spot on, and he demonstrates a touching sympathy with the Greeks’ predicament, he errs in the same manner that Hans Werner Sinn (an austere critic of Greece who believes that Greece has laid its own procrustean bed) erred in calling for Greece to exit the euro as the best of all evil scenaria. And what is their shared error? To imagine that leaving the eurozone is equivalent to being kicked out of a club for misbehaviour.

Watching this debate unfold reminded me of another interesting split within the group of commentators who like Weisbrot, and unlike Professor Sinn, express sympathy with Greece’s plight. On the one hand, there is the American perspective from which things appear as relatively straightforward: Countries caught in a debt-recessionary spiral which cannot inflate their way out of debt have no alternative but to default. And if default is not allowed within a eurozone that refuses to finance the debt (by means of low interest loans), then the country in question must consider leaving. Nuriel Rubini’s point the other day was precisely that, namely that Greece’s exit from the euro is one of the few feasible strategies available to Athens. However, those who understand the profound difference between a currency union and a fixed exchange rate also understand what I call the Eagles-doctrine.

The Eagles-doctrine? In their hit Hotel California, the Eagles’ last verse was: “You can check out any time but you can never leave”.[2] Thus the… Eagles-doctrine for a currency union (like the eurozone). How exactly does this doctrines hang together, preventing a checked out (i.e. insolvent country like Greece) to leave? In two ways: First, by ensuring that any such move will return the country to the Stone Age. Secondly, by guaranteeing a series of cascades that will cause the whole union to collapse. Let’s take these two ways in turn.

Suppose the Greek PM were to announce that tomorrow morning he will be tabling a piece of legislation in Parliament that paves the way to (a) an exit from the euro, to be effected by next week (an extremely short space of time in which to organize a new drachma issue capable of financing economic activity nationwide), and (b) a default on Greece’s debt (which would be essential given that Greek debt is denominated in euros and a new drachma would devalue to such an extent that the debt mountain would be impossible to scale, even in theory). I submit to you dear reader that within minutes all ATMs in Greece would dry up, as Greeks withdraw all the cash they can. Within an hour, banks will have to shut shop, overwhelmed by the queues of customers demanding their savings (and if the announcement is made after hours, the banks will simply not open the next morning). In short, all economic activity will cease for at least a week. For a country already in recession, this would be tantamount to collective suicide.[3]

But let’s for argument’s sake assume that the Greeks decide to risk such a catastrophe, and that our German partners are only too happy to see the back of us. Soon, I suggest, their joy will turn to despair. Why? Consider the chain reaction that will begin with the collapse of the Greek banks. The ECB will have lost more than €110 billion in one instant (money owed to the eurosystem by the Greek banks) plus up to €40 billion of the Greek bonds that it has purchased on its own account since May 2010. Someone (call me Germany) will have to recapitalise the ECB. Moreover, the eurozone’s private banks will start falling like sad dominoes not only because they are owed serious money by the Greek state but also because they are owed money by others who are owed money by the Greek state. Again, someone will have to prop up the remaining eurozone’s banks at a cost that is better left uncontemplated. And as if this were not enough, the money markets will start betting on who will follow Greece into the wilderness. I am prepared to bet many months’ salary that the punters will put much money on Ireland coming (or leaving) next. These bets will, by themselves, increase fears within Ireland (and in the mind of Irish asset-holders) that Ireland’s euro membership may be in peril, thus liquidating their real estate holdings and taking every euro they have off the Emerald Isle.

There is no need to continue to drive my point home: Once these events occur, the markets will turn to the next exit prospect and then to the next until Germany will decide it has had enough. At that point it will bail itself out of the eurozone and the common currency will perish. Could that be a good thing? Why should Germans fear such a prospect, especially if they can then forge a new currency union with ‘like-minded’ nations, like Holland, Austria and Finland? Because, the simple answer is, if they do this, the new currency (an NDM?) will skyrocket, propelled by the collapsing economies around this new union and, importantly, against the backdrop of a global currency war that will ensure a massive drop in the demand of Germany’s exports.

In the United States Paul Krugman seems to understand this, [4] even though he is tempted by the thought that a desperate government may adopt the desperate exit strategy. In Europe, with the exception of some German austerians (like Professor Sinn, who seem unaware of the hideous truth that producing gleaming products which foreigners want to buy is no guarantee that they buy them), almost everyone understands that a Greek exit from the euro is a catastrophe of the highest order not just for Greece but for Europe as a whole (even for the global economy, one might add). Wolfgang Münchau, as reported by eurointelligence.com today, impresses upon his reader the crucial point that “monetary union has some state-like characteristics” and that, as with any state, its disintegration is fraught with dangers and traps.

Having said all that, Mark Weisbrot’s concerns (as well as Roubini’s Krugman’s etc.) remain in force: “Greece” he writes poignantly “cannot afford to settle for any deal that does not allow it to grow and make its way out of the recession. Loans that require what economists call “pro-cyclical” policies — cutting spending and raising taxes in the face of recession — should be off the table”. Unfortunately, not only do they remain on the table but new loans made conditional on fresh, harsher pro-cyclical policies are imposed as well. So, is there an alternative?

The obvious alternative that anglo-american pragmatic minds (including Nuriel Rubini and Martin Wolf, see his piece in the Financial Times today) immediately think of is a default. Indeed, if Europe is unwilling to finance a burgeoning Greek debt forever, and an exit from the eurozone is ruled out, default within the eurozone is the only option. Now, there are those who argue, with some justification, that a Greek default within the eurozone will trigger a series of similar defaults that may end up being as devastating in their effect as that of a series of exits (beginning with Greece) from the euro area.

First and foremost among these anti-default polemicists is Lorenzo Bini Smaghi, the ECB board member (who uniquely manages to retain a modicum of independent thinking while still an ECB functionary). In a recent talk he rounded up his narrative by quoting from David Marquand’s book The end of the West: “The economic crisis itself, like its predecessor in the 1930s, is political, not technical… The world’s economic blocs will have to find painful answers to urgent problems; and the allocation of the pain will be a supremely high-political matter. It will raise profound questions of distributive justice… the proper balance between the claims of poor and rich nations…But for the Union’s leaders to opt out of the global search for answers would be a betrayal of their citizens. And they will be unable to opt in if they cannot speak with one voice and lack the democratic legitimacy to carry their people with them.” [Emphasis added.]

This conclusion to an important talk sounds all too cryptic at first. But soon enough the message shines through: High interest loans, austerity and denial are jeopardizing the European Union’s democratic legitimacy, both with German voters (who are exasperated by the vicious cycle of throwing good money after bad, and end up concluding that the Greeks et al must be kicked out) and with Greek, Irish etc. voters (who feel that they are assigned a Sisyphean task by a heartless Goth taskmaster).

What might a new path look like? What do we put in the place of new expensive loans for insolvent eurozone nations, in exchange for destructive austerity? Stuart Holland and I have suggested one such path (click here for our Modest Proposal and here for a more recent rationale for it). Others may come up with alternatives. The one option we do not have is the one that the European Union is, currently, insisting upon against all rhyme and all reason.

[1] Click here for a related article in Die Zeit and here an interview in Seudedeutsche.de

[2] Click here and jump to 5’ 32’’ if you are too young to remember that 70s hymn. Thanks are due to my friend and colleague Gary Dymski, of the University of California, for bringing up the significance of this line (in the context of California’s deficit woes).

[3] Weisbrot writes: “You can be sure that the European authorities would offer Greece a better deal under a credible threat of leaving the euro zone. In fact, there are indications that they may have already moved in response to last week’s threat.” Sure. The only problem, of course, is that the threat of an exit from the Europe is hardly credible, if my analysis is correct.

[4] He, correctly, writes: “Argentina had a supposedly irreversible peg; it still had peso notes in circulation, so the mechanics of exit from the peg were much easier than exiting the euro would be. And the mechanics matter a lot; they could make all the difference between a brief period of shock and an extended financial breakdown.”


  • The real problem here is that we don’t have leadership in Greece or Europe. I don’t want to give up national treasures and assets and sovereignty as part of a rolling bailout that will ultimately culminate in default.

    If this is what we are looking at then I would rather default now, and experience the wrath of bank runs and a system breakdown for a week or two or whatever the transitionary period is. The scenes depicted by those living in Argentina in 2001-2002 are scary, but so is debt peonage.

    If we had a nationalist leadership that was prepared to negotiate reasonable terms that did not sacrifice our independence, then I would be willing to strike a deal, but I don’t believe that the goal of Eurocrats is to cut Greece any slack. They want to consolidate more power in Brussels, and if they are going to negotiate haircuts for bond holders then they are going to want major political concessions in return.

    I used to be a supporter of european integration, but upon closer examination and after years of watching the process evolve, I no longer believe that this is in the best interests of the citizens of europe. It may be in the interests of big business and of nation states, but it will ultimately lead to a further breakdown in accountability and a loss of control by the peoples of Europe over their governments and the governing process. This is obvious in the governing structures and in the revisions made under Lisbon.

    Unfortunately, the problems in Europe originate in the global fiat financial system and not in the Euro. The debts are too large, and they represent the foundation of the entire asset and capital structure of the banks. The entire fixed income universe is under threat, and since banks are inherently bankrupt, a default could spark a total collapse. No one knows just how leveraged the entire system is. We are all guessing. Even the BIS and the IMF are estimating what they think the dangers are.

    If we had strong leadership I would say that default is not inevitable. The problem is not that there are not solutions, but that there is no one there to implement them.

  • is there no way to first issue drachmas and then announce the exit, in order to prevent our banks from collapsing? are there technical reasons for which this is impossible, or is it considered very autocratic and limiting of the personal rights and freedom of a country’s citizens? but isn’t this freedom in grave peril anyway, should our problems not find a solution soon?

    • It’s practically impossible to do something like that without getting a bank run (everyone withdrawing their money from the banks). Even if there was an order to stop bank withdrawals it’s impossible to run a country without any bank transactions. And distribution of drachma everywhere takes time (not to mention all the changes in billing everywhere). It’s a mess…

  • There is no reason to recapitalise a central bank as a central bank can always expand both sides of its balance sheet. It cannot become insolvent because it is not capital constrained like a commercial bank, it can show a negative capital position on its balance sheet. Germany if it wants to continue it’s export oriented growth model could instruct its central bank to purchase the currency it is targetting for export indefinitely. Have you checked the deposits fleeing Ireland at present, they are not slowing down but increasing.
    The ATMs will still function, I’d be surprised if the Greek Government are not printing new notes at present. It would be a dereliction of duty if they weren’t. Maybe Germany would be upset if the Greeks stopped buying all their military equipment. Eating bread is soon forgotten.

    Why do people still use the term partners in the European context, it’s a master and slave position. The PIGs would be put in their pens and would be allowed out only when they behave. Germany has everything she wanted, she controls foreign markets by locking them into the euro. The euro is Europe’s gold standard and the first to break free will recover, it will not be pretty but then independence never is.

    Your being dishonest when you write: without any fiscal transfers. Transferring national debt to Europe and creating a european bond that has to be serviced with tax payments is a federal europe. Alexander Hamilton done the same thing when he folded the US state debt into Federal debt and there began the USA. It wouldn’t lesson the problem at all, if you compare California’s debt to any European country’s debt they are still insolvent, some don’t know it at present but time will tell.

    The Stability and Growth pact was nonsensical to begin with because government deficits are not under the control of the governments to begin with, they are determined by the private sectors saving.

    Your proposal does not solve the current account imabalances within the Euro area, but could infact make them worse. You don’t notice these imbalances in the US because of federal distributions. For Europe,you would need a Federal Government. Is it any surprise that the countries in trouble are the ones that have had hugh current account deficits?

    And I don’t like your proposals telling governments what they can and can’t do, and then they hide behind the law like servile pigs to inflict more damage. The problem is that the European governments have not brought their people along with them, they have been deliberately dishonest and the people don’t trust them. The crises has to get worse for people to start questioning their economic system, plastering over problems solves nothing. People have not learned what has happened, and so it has to repeat until they do. European governments are operating within a foreign monetary union, they have no control over their currency.

    • Dear Yani,

      I would like to thank you for your elaborate analysis on the return-to-drachma scenario.

      I understand that one of your main concerns is the default of the Greek banks which, in turn, will trigger a chain reaction that will gravely affect ECB, the private European banks and eventually the Eurozone as a whole.

      Taking into account the similarities that may be found between the Greek crisis and the Argentinian crisis, I would much appreciate it if you informed us on how many Argentinian banks (by number and percentage to the Argentinian banking system) defaulted after the abandonment of the exchange peg.

      My impression is that these figures were, in the final turn, lower than expected and that in any case foreign banks exposed to Argentinian banks were not decisively affected.

  • Would the ECB require national governments to recapitalise it in the event of a Greek default. I understand the the ECB would lose the emergency loans provided to the Greek banks and the the Greek bonds it has bought from the secondary market. But can it not create euros to replace the assets (emergency loans and Greek bonds in this case) it has lost here? Or use some kind of quantitative easing to buy equivalent assets (other government bonds?) to replace the Greek ones?

    I know the ECB have seemed extremely adverse to any kind of quantitative easing but would a default event panic them into some kind of radical action?


  • I’m from Austria living in Germany and I really really like your modest proposal. That said I don’t think it will fly with the citizens of the so-called core EZ countries. Your proposal is heavenly dependent on the ECB doing things true BuBa dogmatists (99% of Germany) consider inappropriate for a “good” central banks. Plus I’ve my sincere doubts whether the ECB people themselves would go along with your proposal since they seem to be on a mission to outdo BuBa central bankers.

    Me thinks the action must come from the debtors. (“Owe the bank $100, that’s your problem. Owe the bank $100 million, that’s the bank’s problem” — J. P. Getty) Instead of walking like sheep to the slaughter the debtor nations should realize that they have enormous leverage in negotiations. But they need a credible plan B to your proposal. In negotiation, the one key thing that really strengthens your position is the ability to walk away from the deal.

    Instead of announcing an exit from the € the Greek PM can announce that the government will issue new Drachma parallel to the Euro and the new Drachma will float against the Euro. But the Greek government will only accept Drachma to settle tax liabilities and will enforce tax payment in new draconian ways. Plus any future government expenditure will solely happen in Drachma. For some time there will be some mess but that’s it. And if the Greek government chooses to bring into existence its own FIAT currency following the logic of MMT it also don’t has to turn to bond markets. Problem solved.

    Except that the existing debt is now in foreign currency. The Greek government can offer Drachma bonds in exchange (a haircut) or tell the EU to read the part of your modest proposal which deals with our EU zombie banks. That would be my plan B to force the “core” of the EZ zone to the negotiating table. Otherwise they won’t show up.

    • Stefam, I am almost wholly in agreement with you. With one small difference: The Greek government need not issue a parallel currency as a bargaining strategy. All Mr Papandreou needs to do is call a Press Conference to announce that the Greek government, cognisant of its inability to repay more expensive loans, refuses to borrow more money unless the eurosystem is revamped. Were he to say this, thus implying default, the BuBa fundamentalists will be forced to undergo a major rethink…

  • Being a huge fun of rock music and an “inactive” economist (as i have been employed in the public sector for the past few yers), i can honestly say that after the “Eagles’ doctrine” the meaning of the song “Hotel California” has never been so clear to me.

  • Being a huge fun of rock music and an economist, (“inactive” though as i have been employed in the greek public sector for the past few years)i can honestly say that after the “Eagles’ doctrine” the meaning of this particular song has never been so clear to me!

  • When european private banks had liabilities (leftovers of the 2008 crisis), they were supported with assurances by european governments to aquire liquidity from ECB. Some of these banks were giving loans to us (PIIGS) utilizing this liquidity. Then the “evil” markets aimed at recording assurances in european countries’ debt by attacking weaker countries, possibly expecting that some banks will have to take the hit in the end. Am I wrong that this triggered the current european crisis? Am I wrong that this could only happen in eurozone, where countries are committed to borrow from private banks, and cannot aquire loans from the ECB? Isn’t this an institutional vacuum in the eurozone, one that turned a private banking problem to a sovereign debt crisis?

    Another thing. Is there any country in financial history that has reduced its debt-to-GDP ratio significantly with further borrowing at interest rates higher than inflation? Isn’t borrowing from private banks (i.e. at interest rate higher than inflation) again an institutional vacuum -or is this intentional? This attitude of our eurozone partners, that demands that Greece borrows at 5% interest rate (initially 6%), so that it is “punished” for its high debt to GDP ratio, is it solidarity? It sounds to me like using the whip on slaves. By now everyone nows that the complaining german taxpayer is making money on new loans to Greece. The next thing is that he feels the master of the carriage? Of course, it is not his fault, but german policy will have to reflect on germans after a while… Not only that, but EE/ECB/IMF terms of borrowing (fiscal policy terms) dictate that free democratic countries should achieve consent of larger political parties or forge democracy in order to meet them. The fraud that the german taxpayer is losing money to bail out Greece is now uncovered, so there is no excuse for the finacial and political extortions.

    Am I seriously wrong regarding economics professor Varoufakis?

    Stamatis Kavadias, PhD

    • Of course it is an institutional lacuna within the eurozone that has promted the crisis. The markets understood well that when aggregate debt is distributed unevenly, on the weakest shoulders, and that no common debt were possible, they started betting on which member state would fall first. It would never happened in the US… As for your second question, the answer is a definite NO. There has never been a case in global economic history where such a debt burden was contained by means of new loans and savage austerity within a currency union.

  • One more question: If Greece desides to leave the eurozone, is it certain that it needs to default? Isn’t it possible for the government buys in advance banks that will become insolvent?

    • It is a dead certainty. If it leaves the eurozone, its euro denominated debt will rise inexorably. While the Banks can be kept running through Bank of Greece liquidity, the inflationary effects of this will further increase the drachma value of the existing foreign debt. See my most recent post entitled “When push comes to shove? Exposing the incredible threat of Greece’s forced exit from the eurozone”.

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  • Then Yani am I correct to presume that you predict the SNB’s move to “buy foreign currency in unlimited quantities” (their wording), in order to preserve a maximum 1.20 CHF/EUR ratio, bound to fail? We’re looking at a reversed logic than the one that led Bank of England to the events of Black Wednesday. What would stop this new monetary union from expanding the monetary base of the new currency to levels that, through inflation, reaches a desired exchange rate? I can only think of the impossible trinity theorem.

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