Two-Tier Currency as Remedy for EUR Crisis

Montreal, Canada

Since the emergence of the European credit crisis 12 months ago, a host of suggestions to remedy the debacle have been put forward. These range from a Brady-type bond restructuring, which occurred in the late 1980s and early 1990s in Latin America, to the dissolution of the EUR altogether and the reintroduction of independent European central banks.

The Europeans don’t want to lose the EUR mainly because of the massive resultant costs associated with its destruction. The banking sector would nosedive like a Boeing 747 at 37,000 feet with no fuel; European banks are still under-capitalized and the recent Basel III accord will only drain more capital from bank balance sheets. European banks need more cash.

The problem with a debt restructuring in Greece, Ireland, Portugal, Spain – and whoever follows suit – is the associated cost of that rescheduling. The Germans, more than any other nation, would suffer the biggest write-downs or losses, followed by the French, Italians and the British. Basically, a debt restructuring would cripple many banks and probably trigger another financial crisis.

In the absence of a default or debt restructuring under a Brady Plan or something similar, a two-tier EUR might be a solution.

The peripheral eurozone countries or those suffocating by rising debt loads and the deflation imposed on them by the European Central Bank (ECB) and their inability to print currency might introduce a EUR II or a peripheral EUR currency.

Countries using the EUR II would have to pay much higher interest rates than core EUR (Germany, Holland, France, Austria) but would at least retain some margin to let that unit fall in value, thereby inflating their way out of an economic morass. The EUR now, as it stands, is going to make any sustainable economic recovery in Ireland, Greece, Portugal and Spain extremely difficult because these countries need a weak unit, not a stable one. A strong EUR is not in the immediate best interest of the eurozone.

I’m not sure who will issue EUR II or who decides to join or re-enter the EUR. But at least introducing a peripheral unit or basically a “banana” EUR would offer a temporary solution to those weak economies strangled by deflationary policies and severe cuts. Without a two-tier currency system, at least a temporary mechanism, the EUR as we know it will eventually head much lower and, possibly, remain weak for years to come.

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