The Euro Zone X Factor

By Finance Addict

Whatever one thinks about Lord Wolfson’s euro-skeptical meddling, it certainly has been entertaining. The British baron’s offer of a £250,000 prize for the best ideas to deal with a possible breakup of the eurozone has brought all sorts of people out of the woodwork. (Including this precocious 11-year old.) But one of the most fascinating ideas on the shortlist has come from Neil Record — although I’m not sure that my takeaway was his main intent.

Suppose that a country does leave the eurozone — this was the starting premise of all the responses to Wolfson’s essay contest. Greece, as the weakest link, seems the most likely candidate. But on the other hand it’s possible that one of the strongest countries chooses to go its own way. Of course we’re talking about Germany. Whether it remains in the euro or decides to take its chances by introducing a new Deutschemark, the fact is that in the case of a euro breakup, Germany is where it’s at. Its fiscal position and reputation for prudence is among the strongest of all developed countries. If it were on its own then its currency would rise to reflect this. So, to the extent that you can choose, you will want to get your banknotes from Berlin.

Some of the economists on Lord Wolfson’s shortlist imagine a scenario where, even post-breakup, all euros are equal. This is not the case with Neil Record’s plan. In fact Record, a former economist with the Bank of England, reminds us that this is not really the case even today, in the absence of any breakup.

It is worth noting, to the surprise of many commentators, that Euro notes are not formally issued by the ECB, but by each member State National Central Bank. Each Euro note is accordingly marked with a prefix letter according to its issuer as follows:

So a Greek (or indeed any non-German resident) could sort through his or her notes as they acquire them, and pass all non-X prefix notes on to shops or back to the bank, and retain all X prefix notes, perhaps in the safe deposit box in Germany. This is as close to a free financial option that any individual will ever be faced with, since the chance of loss is nil (the cost of holding ‘X’ prefix notes is the same as holding any other prefix banknote), and even compared to a bank account, the lost interest is negligible. The opportunity of gain (even if the probability is small) is very substantial indeed.

Cumbersome? Yes. Crazy? Maybe not, if you believe in the merits of Record’s full contingency plan for a breakup of the eurozone. As to the value of contingency plans in general, remember that it has been more than a year and a half since the eurozone crisis broke out in earnest and, despite all assurances to the contrary, it’s not fixed, it’s not getting better and it may actually be getting worse (see Spain.) No one knows what the outcome will be, we only know what politicians are afraid to say — that a breakup of the eurozone might be inevitable. If you’re a European who has steadily decreasing faith that the politicians or the ECB can stabilize the situation then by now you are surely starting to think outside of the box. And you certainly wouldn’t be the first.

Record reminds us that

On 1 Jan 1999, national currency banknotes became ‘fractional denominations’ of the Euro. Exactly the same needs be done in reverse whenever [Record’s] Plan comes into force. So Euro banknotes will become ‘fractional denominations’ of new national currencies. This will mean that apparently similar notes (except for the prefix) will become worth different amounts, and the exchange rates between them will be highly variable.

Could X mark the spot?


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1 Comment
  1. NigelRHolder says


    The Problem

    Eurozone has adopted monetary union without fiscal union. Member states have
    applied different fiscal policies, leading to disparities in relative
    competitiveness, which can only be restored by currency devaluations. The
    Eurozone is absent a mechanism for differential internal devaluations.

    cannot be imposed at a degree greater than that which the populations of the
    weaker states will accept without negative growth and social unrest. And austerity
    alone will not solve the competitiveness problem.

    debt bailout strategies will delay the breakup of the Eurozone, but cannot
    solve the competitiveness problem. 
    Fiscal union, allowing massive transfers of wealth internally within the
    Eurozone would resolve the problem. However, politically, fiscal union cannot
    feasibly be achieved in the relatively short timescale necessary to avoid
    unstructured defaults by one or more of the weaker states.

    political aspiration of an “Ever Closer Union” is a major cause of premature
    monetary union in advance of the necessary political and fiscal union. Nevertheless,
    the majority of member states’ populations continue to support this ideal.  Any solution must reconfigure the monetary
    conditions within the Eurozone whilst preserving the integrity of the zone.

    The Criteria for a Solution

    Weaker Eurozone
    member states must be able to devalue to regain competitiveness

    Political and fiscal
    union must be preserved as goals to be achieved in the medium to long term for
    as many Eurozone member states as possible.

    The solution must be
    perceived as practicable by the European political class, by the peoples of the
    Eurozone member states, the global community of financial institutions, the IMF
    and the G20.

    The solution must be
    seen as dealing fairly with all the peoples of the Eurozone member states, and
    with all the legal entities that have a contractual locus within the Eurozone.

    The solution must be
    organised around a time-tabled and fully funded programme of action that will
    bring about resolution of the crisis with certainty, and within as short a
    timescale as is feasible.

    The Solution – A Dual Currency

    ECB should issue a new currency – provisionally called the Secundo – to be
    legal tender in all Eurozone countries, in addition to the Euro. This would be
    achieved by the exchange of all old Euro notes for New Euros and Secundos at a
    ratio to be determined differentially in each member state. Euros held
    electronically in Eurozone bank accounts would similarly be electronically
    exchanged for New Euros and Secundos at the same National ratio.

    value of the Secundo would be set in relation to the Euro at an exchange rate
    that would be fixed in perpetuity – the Fixed Euro Secundo Exchange Rate (FESER).
    In this proposal the FESER is set at €0.75.

    Greece, where it is assumed that all Euro liabilities would be exchanged for
    Secundos, government bills and all public sector payrolls would be paid in
    Secundos instead of Euros. In member states where the requirement for
    devaluation is necessary, but of a lesser scale than in Greece, then government
    bills would be paid partially in New Euros and partially in Secundos. 

    France elected to pay all it bills and its public sector payroll in the
    proportion of 90% New Euros, 10% Secundos against a 100% old Euro liability, it
    would achieve devaluation against a country that retained the Euro for all its
    liabilities (e.g. Germany) of 2.5%.

    Secundos would be usable as currency at three-quarters of the value of the Euro
    in all Eurozone countries, the integrity of the Eurozone would be preserved. In
    addition, whilst the FESER would be fixed in perpetuity, member states could
    engage in small scale devaluations by changing their National Currency Ratio
    Determination (NCRD). This flexibility would assist a return to monetary
    stability throughout Europe.

    holders of bank accounts in the Eurozone would need to have current accounts in
    Secundos set up. All commercial enterprises in the Eurozone would be required
    to price in both Euros and Secundos and to accept payment in either or both

    stability would be ensured by the ECB asserting its role as lender of last
    resort for both the Euro and the Secundo. To avoid excessive easing of monetary
    policy the ECB would need to ensure that the combined value of New Euros and
    Secundos in circulation at the time of Secundo issuance was equivalent to the
    value of old Euros previously in circulation. 
    The timing and mechanisms involved would be determined by the Secundo
    Implementation Panel (SIP).

    prevent uncontrollable arbitrage between personal debt, corporate debt,
    mortgages, sophisticated financial instruments and sovereign debt, this
    proposal applies a consistent approach to the re-valuation of debt at the time
    of Secundo Implementation, with the only variable factor being the member state
    or countries within which the creditors and debtors reside.

    largely obviate the need for arbitration or contract renegotiation between
    creditors and debtors in different member states or countries, the principle of
    a Contract Renegotiation Devaluation Threshold (CRDT) is introduced. Where the
    differential between the devaluations applying to two contracting parties at
    the time of Secundo Implementation is less than the CRDT, rules define how debt
    is to be valued in Euros alone (when the creditor is an External Contracting
    Party); or re-valued in Euros and Secundos when the debtor and creditor are in
    different Eurozone member states.

    full proposal addresses in greater detail:

    How debt
    reconciliation could be managed, for all types of debt, within Eurozone member
    states, between member states, and in external countries. (The CRDT principle
    as adduced)

    An implementation
    plan showing key decision points with a putative timescale

    Risks to the Dual
    Currency Project in the form of a risk register

    The rationale
    underpinning the proposal, based upon the need for all systems to have multiple
    control mechanisms that naturally operate at different rates

    How to address the
    three major arguments that will be put against the proposal;

    Cost of implementation,
    (A budgetary indicator calculation is put forward)

    Difficulty in

    Uncertainty implicit
    in innovation


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