There is no easy way out of the eurozone, as Tim Harford explains with eloquence and good humor. But here is my best guess at Wolfson’s query:
1. Issue a surprise announcement that all euro deposits in Ruritania will be converted into pesos (or whatever) at a new and lower yet defensible rate. If I try to withdraw my ten euros from my bank, I receive an IOU for ten pesos which is worth say six euros. Over time the government will replace these IOUs with a new paper currency.
2. Let physical currency euros leave the country, and stress they will be honored, in any case they are not easy to confiscate or convert. And a country may need them as a partial money during the transition. Not trying to confiscate them will mean that a lot of the euro currency stays. There will be a dual currency regime for some time to come, but the medium of account will become pesos not euros.
3. If you borrowed money denominated in euros, from a Swiss or German bank, that is between you and them. Obviously a lot of borrowers will be in partial or total default, given the whack to their bank accounts. Let the northern nations bail out their banks, they won’t send tanks to extract the funds from good ‘ol Ruritania. Who knows, the rest of the eurozone might be prompted to set up a sensible bank resolution mechanism — working through the ECB of course — though don’t count on it.
4. The assets of Ruritania banks, namely loans to Ruritania citizens, will be redenominated to pesos. Labor and rental contracts will be redenominated too.
5. Nationalize parts of the banking system if need be, so much the better if you can pass on this one. If the bank is essentially empty, that is a deflationary shock. Have the government take over the bank and fill it with new printed money to restore deposits and counter the deflationary shock. If the country cannot trust its nationalizers, they should just print up more pesos and nail them to the bank balance sheets, risking the resulting corruption and drain of funds.
Are we on track so far? The consumption of imports will fall I believe.
6. What about default? If your country is running a primary surplus (Italy yes, Greece no), partially default on your debt but make strict promises to resume payments ASAP. Capture some wealth from the foreign banks and start the game all over again. Without a significant primary surplus, the (temporary?) cessation of foreign borrowing would mean that the country has to cut government spending further. Make a political judgment here but consider not defaulting; default may be unavoidable for Greece in particular but you can’t blame my plan for how deep in the hole they are.
Let’s sum up which problems have been addressed and which not. The domestic banking system is saved, at least provided the new conversion rate is credible enough that no one expects a repeat of the depreciation. It’s key to make that first announcement a real surprise, good luck! A negative wealth shock will come anyway and my plan has accelerated the arrival of that shock; the best one can do is to combine it with monetary expansion and the positive export shock from devaluation. To fix the external banks, the wealthier countries will need to exercise and perhaps improve their LOLR powers, but that is the case under any plan, not just this one.
Admittedly this plan makes the wealth loss in Ruritania quite transparent, which may be politically unpopular, but that transparency eases the economics of the transition.
Voila! Rinse and repeat as necessary. A lot of this would be eased by high inflation from the eurozone itself but a) that would involve collateral costs on the healthier economies, and b) in any case it doesn’t look like it will happen. I’m sticking with what a small country can do on its own.
No need to write in the comments section that this is “illegal.” Breaking the three percent deficit rule, as France and Germany did, was illegal too. Ruritania will not be hauled before a court of law and I also predict Ruritania will not be ejected from EU per se. Maybe their agricultural subsidies will be cut, let them eat floating exchange rates I say.