12 January 2012

John Wyles: A living will for the euro?

At a time when the political atmosphere is already funereal, Europe's leaders could do worse than experiment with developing a ‘living will' for the currency area. Intended to be applied to international banks that are too big to fail, the concept is entirely appropriate for a eurozone whose failure would wreak catastrophic damage on the global economy. It may even yield a blueprint for avoiding a disorderly break-up of the single currency.

When applied to a bank, a living will has two elements. One is a recovery plan to get over a crisis of liquidity or of solvency. Measures to be adopted might include the disposal of assets, a reduction of risk or the restructuring of liabilities. Their equivalents in the eurozone are the austerity measures and fiscal discipline regimes currently being pursued in Greece, Portugal, Ireland and Italy. They are not at all a guarantee of recovery, although eurozone leaders pretend that they will prove very important to recovery.

In banking, the second part of a living will is meant to ensure that the taxpayer will no longer have to finance bail-outs of the kind that looted the public exchequers in 2008-10. This is called ‘resolution'. In the context of the debt crisis, ‘resolution' could mean temporarily taking a country out of the eurozone and letting it operate a parallel currency in a managed float against the euro.

Inevitably, this national currency would devalue, thereby restoring indispensable economic competitiveness. The resolution country would not necessarily need to recreate its own notes and coins, and the euro would continue to circulate in all members of the eurozone.

Adoption of the parallel currency would need to be accompanied by a number of measures, including capital controls, internal structural reforms and supports for the European banking system. Critically, all foreign debt repayments in euros would have to be guaranteed, although repayment periods might be lengthened. When a national parallel currency achieves parity with the euro for a certain time, rehabilitation would be completed and the drop-out could be re-admitted to the eurozone.

Apart from avoiding a disorderly implosion, a living will based on a form of internal quarantine for countries needing transformation would offer investors a much clearer vision of a eurozone recovery strategy. Put alongside much tighter fiscal rules, stricter surveillance and semi-automatic punishment procedures for badly behaving governments (all soon to be in the policy armoury), a living will might begin to restore confidence and trust. Once in place, a living will might not need to apply to any other country than Greece.

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