Greek exit—Strange Currencies

How could an introduction of a new currency following the Greek debt crises work in practice? Plausible measures and eventualities are outlined by Dr Warren Coats Jr, who led the International Monetary Fund in introducing a new currency to Bosnia, and participated in introductions in Iraq, South Sudan, Bulgaria and central Asia.

Background

While the Greek government and public both express a strong will to maintain the euro as their currency, euro zone members continue to threaten that the Greek public cannot reject a bailout while keeping the single currency. In the event of a new currency being created, the dynamics of the situation are susceptible to substantial change.

What is the likelihood of Greece redenominating a new currency?

It is unlikely that Greece will undertake a clean replacement of the euro with their own currency, as both the public and Syriza favour keeping the euro. More probable is that the government will begin to issue euro IOUs, should the government have a shortage of real ones with which to pay salaries and pensions. These IOUs will be given value the same way any fiat currency is—by making them good for paying taxes. People will, naturally, confer more trust upon the real thing so that the IOU vouchers will quickly fall to a discount with real euros. The scale of this fall will depend on how many the government must issue.

What have been the experiences of other nations who have redenominated?

Different nations redenominate for different reasons. In 2005, Turkey redenominated 1m lira as 1 new lira to signal a new and mature fiscal policy with greater outward credibility. Afghanistan redenominated in 2002 as part of a broad programme of political and economic reforms.

Owing to lingual, religious and ethnic homogeneity, Greece would avoid some of the disputes that can surround formation of a new currency in countries divided along lingual, religious or ethnic lines. Bosnia’s creation of a new currency was dominated by disputes among its three religious groups (Orthodox, Catholic, Muslim) making it impossible to agree on whose face or which building to put on bank notes. It was only once all parties agreed they really wanted a new currency that those problems could be quickly resolved.

What is the legal status of the new currency?

Governments creating a new currency to replace an existing one will issue a legal tender law establishing the new currency as legal tender. This will include the terms under which the old one can be redeemed for the new one, and would need to cover the redenomination of market prices. I would expect Greece to fix their new currency, one-to-one, to the euro in order that all prices in the market would remain the same in the first instant, except being named drachma, or whatever other name was agreed on.

How would the new currency affect existing agreements?

An IOU version of the currency would be usable within Greece, but not for payments outside of the country. Given that Greece has more or less achieved current account balance, earnings of real euros will likely be sufficient to cover the cost of imports.

Domestic bank deposits would either be forcibly redenominated or depositors given an option of whether or not they wish to redenominate. All government contracts would be forcibly redenominated and provisions would be made about the redenomination of other contracts (forced or voluntary).

The issuance of a new version of the euro would quite probably propagate a fall-off in tax revenue, thereby making Greece’s fiscal situation even more difficult, whatever the performance of the real economy. Greece would possibly experience a harsher ‘austerity’ than would have been required by the institutions even with a full repudiation of its external debt.

How would the transition take place, and on what timeline?

A designated exchange period and procedure would be defined as part of replacing the euro, during which old bank notes may be redeemed for new at the legally fixed rate. Thereafter, the rate would no longer be guaranteed, being market determined. When the euro replaced previous European currencies, a long exchange period was allowed but generally transitions take place over a much shorter period—for example, one month with additional provision for those traveling. Arrangements must be made to destroy the old currency or return it to its issuer if it will continue to exist abroad, as in the case of the euro. Provisions are needed to prevent fraud such as redeeming the same notes several times for new.

Interviewed by Julian Sayarer.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

 

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