The Greek Kosovo scenario

The general assumption in the Greek crisis is that, in so far as there is one, plan B — Grexit — is the introduction of a new currency. I think that actually Greece using the euro outside of the Eurozone is more likely as plan B. It’s still very unlikely because it doesn’t make sense at all from the point of view of the Eurozone, but it’s fun to play with as a thought experiment, and discussing it may help understand why it won’t happen.

There are well known advantages to having your own currency, but in this case a new currency would have big problems,:

  • Risk of non-adoption by people on the street because they don’t trust it
  • Inflationary spiral caused by the economic situation, the sudden introduction and the above
  • Logistic issues (printing new banknotes, converting contracts) which is essentially impossible to do over the weekend, and impossible to announce in advance

The alternative is just to keep using the euro while being outside of the Eurozone. Like Kosovo does, or like Ecuador does with the US dollar.

Map of euro adoption

Going lilac? (source: Wikipedia)

How would it work out?

Paper money

According to the Greek central bank there are about €2000 of paper euros in ciculation for each person in Greece (the actual number may be more or less depending on net flows of notes and coins from other Eurozone countries, but you’d expect this to be a conservative estimate because of net incoming tourists presumably arriving with more euros banknotes than they leave with). These are not going anywhere in case of Greek exit from the Eurosystem, so Greeks have more than enough paper banknotes to go round for a long time, even if they can’t print their own new ones.

(Note that this abundance of paper euros also makes the risk that nobody is interested in new drachmas higher than it would otherwise be.)

No central bank

Grexit would happen through the suspension of the ELA, which would in turn push all Greek banks into bankruptcy (as a liquidity problem at the very minimum) which in turn would exclude them from the electronic payment systems (SEPA, etc). This would also make the Greek central bank insolvent. They could just close it down, which would allow them to default on €50-100 billion worth of Eurosystem liabilities. If you’re a unilateral adopter of the euro you don’t need a central bank, the ECB remains your central bank, at arm’s length.

Look ma, no debt!

While we’re defaulting, given a primary surplus the Greek government can operate with no debt at all, and will be better off than the status quo, even if they can’t borrow for the foreseeable future. So they can default on the whole debt stock from the Troika lenders, and why not the private sector as well given under a balanced budget they don’t need borrowing at all, so maintaining a good credit rating on the markets is pointless.

Having no central bank, the Greek treasury can operate their payments by opening commercial bank accounts (with no overdraft needed!) like any business, with Remnant Eurozone banks, e.g. Deutsche Bank. They can use online banking to manage it, no need for the banks to have branches in Greece. They can also use new Greek banks (see below).

Capital flight is good for you

With no central bank, the Greek banks would have no access to clearing accounts in the Eurosystem. But there are several options here. First, we can assume they would lose all their Eurozone assets (most being owned by the ECB as collateral, and Remnant Eurozone governments could enact special confiscation legislation for local law assets owned by Greek banks, fair game), as well as their liabilities (ECB funding, etc). What is left is basically the local Greek-law loan book, and local Greek euro deposits. As of late December this was approximately balanced. With capital flight it actually improves every day: the loan book can’t walk away, but the deposits (liabilities for banks!) shrink, and capital = loans – deposits, which gets more positive with every euro leaving. Assuming the impairments on the loans are not too far off fair value, and the Eurosystem exit doesn’t create too much new defaults (arguably a risk, but much less so in the Kosovo scenario than in the own currency one), we have solvent banks. If all else fail, a haircut on remaining large deposits should help rebalance.

Liquidity for non-Eurosystem euro banks

These Greek banks are illiquid outside the Eurosystem though, with no access to clearing accounts, but there are solutions:

  • Sell the solvent domestic loan books + domestic deposits to Remnant Eurozone bank(s) for €1. E.g. National Bank of Greece could become part of, say, Santander, who can get liquidity for their new Greek subsidiary operations from the Spanish central bank, still a Eurosystem member, and they have spare borrowing power there given their large balance sheet. Problem sorted. And Greek depositors get their €100k guarantee backed by Remnant Eurozone taxpayers as their deposits are fungible with domestic Eurozone deposits!
  • With the same solvent loans + deposits as above, perhaps less crap stuff sent into a bad bank type entity, reopen the (New) Greek banks as corporate entities which use Remnant Eurozone corporate accounts in lieu of central bank accounts for clearing. This needs a stop gap for liquidity, by either converting the deposits to term deposits (a soft form of capital controls arguably) or possibly finding bridge loans from external private entities. Given the entire deposit base is below €150 billion and may be much less by the time this scenario would unfold, and not all of it will move after an exit (too late), it should not be that hard to find hedgies to provide the financing.

The first variant brings a more generally interesting question: in a currency union, should financially weak regions have their own banks, or should they bank using the institutions from financially strong regions within the union? The answer is probably the latter, as happens in most centralised countries (e.g. most people in Cornwall do not bank with Cornish banks, but freeload on London banks, and quite rightly so; at an (ex-)country level the ex-GDR part of Germany has a weak indigenous banking sector and banks with West German banks, and quite rightly so).

What are the risks of Kosovoisation?

I may have missed something, but I don’t see many problems with this scenario, from Greece’s viewpoint. Long term, Greece would have no indigenous monetary policy, but they were never particularly good at it and monetary policy is of limited use anyway for a small country. They would loose access to EU structural funds, but then they save €400 billion of debt so net positive here surely. The main short term problem is if the Remnant Eurozone tries to cut private Greeks and private entities from their (non-overdraft) mainland Eurozone bank accounts. Possible but pretty hard, and mean. And hard to justify given all this would be triggered by the ECB pulling the plug in the first place.

Why this won’t happen

It should be obvious now that this won’t happen, precisely because it would probably be an okay deal for Greece, while costing the Eurosystem dearly both in nominal terms of treasury + ECB write-offs, in possibly collateral damage, and a very high risk of an associated cataclysm for the European project. The ECB will just not pull the plug unless Greeks do something really stupid (like printing their own unauthorised euros, they do have a print works I think).

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2 comments
  1. I don’t understand well your reasoning. I think that the shock of Grexit is much more important that you realize. The problem is not how much debt is written off, or how much money rest in Greece. The very problem is about credibility. Firstly, people is yet not paying their taxes, so public deficit will be higher than you suppose. Next, in case of Grexit, surely nobody will faith each other, so there will be a liquidity trap without a central bank to rest it.
    In such circunstances, I can’t imagine who will risk to lend to household or enterprise in order to consume and invest. With no source of credit, government in deficit, without authority capable of reestablish confidence, I think that your vision is too much optimistic.

    • cig said:

      In the Kosovo scenario, this is mostly business as usual for people on the street. They keep using euros and their usual bank. Nothing changes. Restructuring and selling out the banking sector would only be visible in the branding of bank branches and bank statements, if at all (the new Greek branches of core banks could keep the existing branding of the old banks). It makes no difference for ordinary people. All the problems you mention (trust, tight credit, etc) are already there. They are already in a liquidity trap. On the contrary, the new banks as restructured branches of bigger non-Greek institutions, trimmed from bad assets (which go to a bad bank resolution thing), would be much more solid than the domestic institutions are now.

      The problem with normal grexit (with a new currency) is the chaos created by having to renegotiate all old debts, or not, into a new moving target that nobody would be able to price for some time. Keeping the euro outside the eurozone eliminates that problem, while allowing a default because if Greece has no (domestic) banks, the creditors can’t retaliate directly any more. The creditors’ main weapon now is that they can force a member state to “do a Cyprus” via the ECB. This only works for member states that have domestic banks.

      The main problem with the Kosovo scenario is not domestic, but what the reaction of the rest of the Eurozone could be. Military action is far fetched, but they could do a blocade, of people and goods from Greece, the ECB could block restructuring deals (e.g. ban say Santander from buying a “good” Greek bank, even if it’s financially sound), or maybe try to cut anyone who deals with Greece off the Euro payments (but that would be tricky given that in that scenario Greece has no domestic banks that the ECB can attack, they’d have to do it at the account level trying to find where the Greek accounts in non-Greek banks are). I think that’s why it’s probably unrealistic — the risk of disorderly institutional retaliation — but it could be a good negotiation anchor.

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