How Germany Can Withdraw From The Eurozone

Includes: DIA, EWG, FXE, SPY
by: Avery Goodman

More than a year ago, on May 2, 2010, this author stated that a Greece default was almost a certainty. See, here. Then, on July 1, 2010, this author penned an article boldly stating that the ECB was outright lying about the solvency of the European banking system. Both opinions were not well received in financial circles. A cold hard calculation, based upon the real numbers, is never popular. But, the truth is often hard to take. Now, over a year later, most bankers all over the world finally agree. The financial world is beginning to accept the inevitable. It has been a long road but it often takes time for people to overcome their prejudices and fantasies and to accept reality.

The Euro is an arrangement that was doomed from the beginning. A fiat currency is based upon faith that debt will always be repaid by the governments that issue it. All modern fiat currencies derive value from government debt and are irredeemable in gold or silver. They have a hard enough time keeping their value in a normal environment but have no chance when monetary unity is not coupled with joint fiscal control. Only a pure redeemable gold specie standard could survive such a state of affairs. Even the gold standard gave way in the 19th century in, the Eurozone's predecessor, the Latin Monetary Union because it could not survive the connivances of "coin clipping" and physical metal debasement practiced by various European nations back then. The Vatican, for example, was the first state kicked out of the LMU and it was because it debased its gold coinage, in violation of the treaty.

It is natural for Germans and other fiscally responsible folks, like the Finns, the Dutch and the Slovaks, to wonder how to escape from an ever increasingly onerous European Currency Union. There is, after all, no obvious legal method to use in withdrawing from the Euro. But, just because something is legally difficult, doesn't mean it is impossible. Germany could easily withdraw from the Euro, even while keeping all its treaty obligations to maintain the Euro as its legal tender. Does that sound like a contradiction in terms? It is not. The Euro can continue to circulate in Germany, even as a New Mark is introduced alongside.

It is true that article 105a(1) provides the ECB with the exclusive right to authorize the issuance of Euro bank notes within the Community. It states that bank notes issued by the ECB and the national central banks shall be the only such notes to have the status of legal tender within the Community. However, banknotes issued by individual states need not be legal tender within the entire Community. The plain language does not require that all banknotes be Euros. There is nothing in the treaty that stops individual states from issuing individual currencies inside their borders. There is nothing that stops those individual currencies from being legal tender in the issuing nation (but not elsewhere) alongside the Euro.

While it may be impossible to kick Greece out, Germany would be well within its rights to simply reissue a "New Deutschmark" only to German banks and depositors in banks that operate inside its borders. Marks would not have the status of legal tender "within the Community" as a whole, but would be legal tender within Germany. The Germans would merely need to establish a new national bank chartered to issue the "New Mark". The issuing bank must be separate from the Bundesbank because one result from the Euro treaty is that the Bundesbank is irrevocably bound to the ECB. The new bank could be a quasi-private institution and could be housed in the same buildings, "sharing" office space with the Bundesbank. All or most of the employees could be drawn from the Bundesbank.

Germany could buy Euros held on deposit with or owned by German banks, prior to the announcement of the new currency. Interest and principal on German bunds would be be optionally redenominated into New Marks, at an announced exchange rate, with bond holders holding a one time option to continue receiving payment in Euros or to allow their bonds to be redenominated. Foreign debt might be bought at a severe haircut in exchange for New Marks. For example, Greek debt held by German banks might be purchased for 40% of its par value. Euros from other nations would still be legal tender within Germany, and they could continue to circulate. Their value, however, would depreciate dramatically.

The reissuance of the German Mark would free German taxpayers from being financially "bled" to death by taxation without representation. Hapless populations can be repressed by any central bank, including the ECB, when the bank engages in money printing, and that is exactly what the ECB is now doing. Germany has lost power and control over the ECB to fiscally irresponsible nations. As a result, the ECB is now engaging in a massive program to monetize otherwise deeply devalued sovereign debt of insolvent Eurozone members at nearly full value. With the ECB engaged in money printing, Germany can, and will,justifiably view a return to the Mark as a desirable step in preventing a repeat of the mistakes of the Weimar Republic.

This quasi-return to national currencies can be done by any solvent members of the Eurozone at any time, either individually or together. Theoretically, a combination of northern nations could issue another supra-national currency, like the ancient Thaler. This prospect, however, is greatly reduced by the recent ruling of the German Constitutional Court which states that Germany's sovereignty cannot be impaired by a fiscal union. So, a New Mark is more likely. It would be nice to see a German mark based on the gold standard, even though it could not be made fully redeemable for many years because of an immediate run of German gold supplies that would result. But, one way or another, Germany can reintroduce the Mark, as either a fiat currency or one backed by gold. Anything that can happen, will happen, in accordance with Murphy's famous law. This will happen and it is only a matter of time.

Investors must be ready. Anyone holding Euros, and who hasn't done so already, should move them to a bank in a solvent member of the Eurozone. That would include Germany, Finland, the Netherlands, and a few others. If and when solvent Europe decides that it has had as much as taxation without representation as it can take, Euros held in Italian, Greek and even French banks may well stay Euros, theoretically "legal tender" even in Germany, but they they will have far less buying power than they have today. It is also possible that the German lead to a national currency would be followed by the Latin nations, and that means a New Lira, New Drachma, etc., and anyone who remembers those endlessly debased, weak currencies, knows what that means without being told.

If a solvent member of the Eurozone decides to leave, there will be costs. The cost of leaving the Eurozone will be several orders of magnitude less than predicted by self-interested banks such as UBS, who will lose big money if nations follow the interest of their taxpayers. UBS appears to be panicking so severely over the prospect, that its analyst, enters a theater of the absurd by predicting war when a currency zone breaks. This is a ridiculous assertion, and it is not substantiated by anything but imaginary history. Exports from the north might decline, but the internal economy would be more stable and well capitalized than under the status quo. The Mark might rise substantially, but for every export that might be lost, increased buying power for German consumers who, for the most part, buy German made goods, would mean an internal sale is made in return.

Keeping the Euro in circulation as "legal tender" as new national currencies are reintroduced is the most orderly effective way of winding down the failed experiment that the Euro represents. The short term cost would, of course, be higher than kicking the can down the road a bit longer, as Americans prefer to do. But, endlessly kicking cans insures even greater problems in the future and does little to solve the problems of the here and now. It is better to spend money to pour new concrete, even if the cost is high, so that a leaking dam is permanently fixed, rather than to try to patch holes with plaster. The long term cost of essentially "leaving" the Euro is far lower for fiscally responsible nations than the long term cost of staying inside a Eurozone now controlled by the more irresponsible member nations.

From an investor's point of view, all European banks are likely to come under temporarily severe stress in the near future. They will feel pain in their balance sheets and some might be bankrupted. In the market, as a whole, European stocks are likely to decline as banks and insurers sell shares to raise cash. American stocks will also decline unless the Fed prints a few trillion more dollars, but by doing that so soon after the last printing episode, it would destroy confidence, and induce double or triple digit inflation. It is hard, therefore, to envison them doing that, at least for a while. A few selected stocks might do well, but broad indexes in Europe and America, will go down dramatically. That will provide excellent opportunities for investors who remain liquid, as they will be able to buy at very favorable prices, and wait for the recovery.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.