Ken Griffin and Anil Kashyap are calling for Germany to reintroduce the Mark and leave the common currency of the Eurozone. Although it may not at first be obvious, having Germany leave the Eurozone is in important respects equivalent to the proposal I talked about in my post "The Euro and the Mediterano." There I tentatively proposed splitting the Eurozone into two currencies, a “North Euro”—which I imagined the press calling just “the Euro”—and a “South Euro,” which I imagined the press calling “the Mediterano.” Now change the names. Suppose that the North Euro is called “the Mark” and the South Euro is called just “the Euro.” In most economic respects, things are the same: only the names have been changed. Here is a table with the three sets of names:
- South Euro North Euro
- Euro Mediterano
- Mark Euro
The German economy is big enough, and different enough from most of the other economies in the Eurozone, that it is a big shift in policy to split Germany off into what is effectively a North Euro zone.
Shakespeare has Juliet say “A rose by any other name would smell as sweet.” But the full context suggests some of the same complexities that arise for the different possible names of two currencies in the current Eurozone. Here is what Juliet says on the balcony, with Romeo looking on, unbeknownst to Juliet:
O Romeo, Romeo! wherefore art thou Romeo?
Deny thy father and refuse they name;
Or, if thou wilt not, be but sworn my love,
And I’ll no longer be a Capulet.
[Aside] Shall I hear more, or shall I speak at this?
'Tis but thy name that is my enemy;
Thou art thyself, though not a Montague.
Nor arm, nor face, nor any other part
Belonging to a man. O, be some other name!
What’s in a name? that which we call a rose
By any other name would smell as sweet;
I take thee at they word.
Call me but love, and I’ll be new baptiz’d;
Henceforth I will never be Romeo
Although Romeo is fully willing to change his name, what Romeo and Juliet really need to change is the bloody conflict between the Montagues and Capulets that keeps them apart: a conflict the names have come to signify.
In the case of the Eurozone splitting into two different currencies, the politics are quite different between the two cases of splitting into the Euro and the Mark as opposed to splitting into the Euro and the Mediterano. For one thing, German national pride could help propel the reintroduction of the Mark, without the implied economic failure on the part of the rest of the Eurozone holding back the process of splitting the currencies (since the other Eurozone countries are not themselves directly taking an action). So it may be that the reintroduction of the Mark is more politically plausible. This is true even if some other country, say Finland, went with the Mark.
In my post “The Euro and the Mediterano,” for the sake of European unity, I propose that the European Central Bank (ECB) continue to be in charge of both currencies, with an informal arrangement that the represenatives of countries in the North Euro and the South Euro zones have more say in what happens with the currencies in their own zone. There is no reason the same strategy can’t be pursued as at least a figleaf if Germany reintroduces the Mark. Germany could soften the diplomatic and symbolic blow of reintroducing the Mark by remaining within the Eurozone governed by the ECB under a “one central bank, two currencies” system.
Although from an economic point of view splitting off Germany from the Eurozone (reintroducing the Mark) should be equivalent to splitting off all the countries but Germany from the Eurozone (introducing the Mediterano for all the other countries), thinking of the split into two different currencies in these two different ways hints at two different ways to handle the transition.
I have been thinking how to handle the transition to two currencies as a result of the comments I received to "The Euro and the Mediterano." As indicated in some of my replies to comments there, I started thinking along the following lines: since stimulating the economies of the South Euro zone requires some depreciation of the South Euro relative to the North Euro. To avoid having everyone pull all of their money out of the South Euro zone, that depreciation needs to be accompanied by an equal difference in the interest rates between the North Euro and South Euro zones (on top of the difference in risk premium between the two zones that already exists). But then I thought “Why not do the transition very fast—in fact, overnight?” What would that look like? One one particular night, the night of the transition, every Euro in bank accounts (or their equivalent) in the North Euro zone would become a North Euro, while every Euro in bank accounts (or their equivalent) in the South Euro zone would become 1.5 South Euros. Euro currency anywhere from before the split could simply be equivalent to North Euros. Since each Euro in the South Euro zone would turn overnight into 1.5 South Euros, there shouldn’t be any reason for investors to pull their money out of the South Euro zone.
But there were other details to worry about. The point of devaluing the South Euro would be to effectively cut the price of goods and services in the South Euro zone, so I thought it might be justifiable to have temporary wage and price controls for, say, a month before and a month after the transition saying that something that used to cost 10 Euros should now cost 10 South Euros, to avoid having everyone multiply their prices by 1.5 on the day of the transition and canceling out all of the effects of the depreciation. The other detail was what to do with debt contracts. I didn’t want to sneak in a repudiation of some fraction of the existing debt of the countries in the South Euro zone. Since the night of transition could be announced in advance, enough time could be allowed for existing short term debt to mature and subsequent short-term debt contracts to be explicitly written to deal with the transition. That would take care of most of the debt. Long-term debt would be messier, but could be handled in a variety of ways—interpreting “Euro” as “South Euro” in preexisting long-term debt would be an implicit bailout, while interpreting “Euro” as “North Euro” in preexisting long-term debt would avoid an implicit bailout. Whatever was done with debt contracts, it would be crucial that labor contracts saying “Euro” in them are interpreted as pay rates in South Euros.
Now, suppose we think about the equivalent transition handled as a reintroduction of the Mark. On the night of the transition, every Euro in bank accounts (or their equivalent) in Germany (and, maybe Finland) turns into .667 Marks. Euros in the rest of the Eurozone stay Euros. There shouldn’t be a huge rush of funds into Germany, because each Euro there only turns into 2/3 of a Mark on the night of the transition.
As in the other case of splitting off the South Euro or Mediterano, there are details. Since the point of splitting off the Mark is largely to raise the effective relative price of German goods and services relative to goods in the rest of the Eurozone, we certainly don’t want everyone in Germany to cut their prices by 33% or so on the night of the transition. But saying that labor contracts saying pay rates in Euros had to be interpreted as guaranteeing the stated rates in Marks would probably be enough to keep this from happening. Because this rule favors workers, it is probably politically easier than the rule with the other mode of transition saying that pay rates in Euros had to be interpreted as pay rates in South Euros.
But it is not all political roses. The savings of Germans would suddenly look smaller in relation to their now higher cost of living, and it might be necessary for the German government to make transfers to account holders based on their account values as of the day before serious discussion of splitting off the Mark began. This would be messy, and it is not clear that the German government can really afford such a transfer, but it could probably be done. What is happening here is very interesting, with or without German government transfers to soften the blow of their reduced value in relation to the cost of living in Germany. The least interesting part is the redistribution among German creditors and debtors, which works in favor of debtors. The most interesting part is that there is a bailout of the rest of the Eurozone hiding in this reduced value of German bank accounts. Why? If the Mark is splitting off, it is natural to interpret debt contracts in the rest of Europe stated in Euros as continuing to apply to Euros, which are equivalent to South Euros in the other naming convention. To avoid an effective bailout, preexisting debt contracts in the South Euro zone stated in Euros had to be interpreted as applying to the North Euro. With this other naming convention, that means that preexisting debt contracts in countries other than Germany would have to be interpreted as giving quantities in Marks to avoid an implicit bailout. If what is effectively the North Euro is called “the Mark,” I don’t see how the politics of the South Euro zone could ever allow that.
So, in addition to changing the effective relative prices between Germany and the rest of the Eurozone, splitting off the Mark from the rest of the Eurozone might actually a way to make a bailout of the rest of the Eurozone politically palatable. Germany gets something symbolic back—the Mark that France insisted it give up as its price for not opposing reunification (see what Martin Feldstein says on this)—while the rest of the Eurozone effectively gets a huge transfer.
A WARNING: Let me end by cautioning against splitting off the Mark with anything slower than the overnight transition I recommend. Trying to introduce the Mark at par with the Euro (1 Euro = 1 Mark) would make financial markets expect a large appreciation of the Mark after its introduction. This would make investors want to put their funds into Marks. Since the nominal interest rate in Germany cannot go significantly below zero (the zero lower bound again), there is no way to stop this rush into Marks by lowering the interest rate in Germany. Such a rush into Marks would be very disruptive. And notice that suffering the disruption from a more gradual transition to the Mark does not in any way avoid the effective bailout. As long as the money currently in German bank accounts is in Euros, its value will fall when the Euro falls relative to the Mark, and any preexisting long-term debt contracts (including debt contracts with the European Stabilization Mechanism) will be worth less in terms of Marks.
Indeed, if the Mark is introduced at par in the near future, it would probably appreciate so fast that even some relatively short-term debt contracts would lose much of their value in terms of Marks, so the implicit bailout might be even bigger. On the other hand, if it were announced that the Mark would be introduced at par after some time, all the other problems would remain, but it would not lead to an implicit bailout, since the bond markets would insist on either debt that is denominated in the not-yet-existing Mark—or in some other “hard” currency—or would insist on high interest rates in Euros.