The Colour Of Money: Currency Considerations Of A Eurozone Withdrawal


Policymakers, the European Central Bank ("ECB") and the International Monetary Fund ("IMF") continue to search for a way to alleviate the Eurozone's debt crisis. Meanwhile there is a growing threat that one or more of the Eurozone Member States ("EMSs") will be forced to leave the single currency. As countries such as Greece, Italy, Portugal and Spain remain locked in debt restructuring negotiations, the words of British economist John Maynard Keynes hold greater resonance than ever: "if I owe you a pound, I have a problem; but if I owe you a million, the problem is yours".

If an EMS does exercise the "nuclear option" of leaving the Euro the potential financial consequences for the global economy are colossal, and companies worldwide are now carefully considering the problems that they may face. Following on from our first paper on the implications of the withdrawal of an EMS from the Eurozone, this paper examines the historical impact of currency redenomination and the key issues for businesses to consider.

Lessons from history

Although over 60 countries have left currency unions since World War II – many such as Pakistan and the Republic of Ireland after obtaining political sovereignty, others such as Germany and France to join the Euro – should an EMS leave the Eurozone there is uncertainty as to the impact on its new currency. Whilst it was not a member of a monetary union equivalent to the Eurozone, valuable lessons can be learnt, and potential implications for the exit from the Eurozone identified, from Argentina's decision to re-float the Argentine Peso ("Peso") in 2002.

When the current version of the Peso replaced the Austral in 1992, after a period of hyperinflation, Argentina's Central Bank ("ACB") pegged it to the US Dollar at a 1:1 exchange rate and in addition the country's financial reserves held one US Dollar for every Peso in circulation. As with the countries in the Eurozone – who have their interest rate set by the ECB – in effect, Argentina had relinquished its sovereignty over monetary policy as its interest rates were ultimately set by the U.S. Federal Reserve. Pegging the Peso to the US Dollar initially helped to stabilise inflation and attract investors, but imports rose (harming domestic producers), GDP fell and unemployment rose. As the country struggled to service its very high international debts the IMF pressed the government to adopt an austerity budget, and civil unrest spread. At the very end of 2001 the country defaulted on US Dollar 132bn of its public debt, and the following month the government allowed the ACB to set a new "official" exchange rate of 1.4 Pesos to one US Dollar. It also redenominated US Dollar bank accounts into Pesos at this new rate. Soon afterwards the Peso was allowed to float freely, and by June 2002 it had depreciated to a rate of 3:1 against the US Dollar.

Many contracts with foreign investors were denominated in US Dollars, as one would expect. With the flotation of the currency...

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