The eurozone crisis can be eased by bringing back the national currencies of troubled economies to run alongside the euro
The eurozone has worked itself into a corner from which it does not know how to get out. At stake is not only the economic wellbeing of Europe, but also its political stability.
On the one hand, most Europeans agree that a breakdown of the eurozone is to be avoided at all costs. On the other hand they recognise that the monetary union cannot survive much longer in its present form. Measures that translate into the likes of Germany having to pick up the bills, or the likes of Greece having to suffer harsh austerity measures in order to repay foreigners won't be viable for long.
Not only are troubled countries structurally uncompetitive, but they are also prisoners of a currency that is grossly overvalued with respect to their own economies. In these circumstances growth is not realistically achievable and massive social unrest may be around the corner as people are forced to sacrifice without the benefit of a glimmer of hope.
Thus, we need to find a way to keep everybody in this monetary union while injecting some life back into these economies. One step in this direction would be what I call "the Lazarus option": troubled countries reviving their own defunct currencies while still staying in the eurozone.
A troubled eurozone country can't keep on printing euros. It can, however, revive its own currency and let it float, undoubtedly ending at a substantial discount from the euro. Both currencies can co-exist as legal tender with businesses and people having the option to use either for commercial transactions.
In such a context, exporters could quote their goods in cheaper local currency, regaining some competitiveness. The government could pay for a substantial portion of its expenditures including salaries and pensions in local currency, reducing by the same token the need to finance itself in euros in the markets, and could also issue local currency IOUs.
Barring eventual debt restructuring, euro-denominated sovereign and private debt would, however, still be there and need to be repaid with more expensive euros, a painful yet unavoidable side effect of such a scheme. For the sole purpose of repaying euro-denominated debts with a revived local currency, an official exchange rate between the euro and the local currency would need to be fixed with the ECB, under strict controls over such operations and capital flows and to prevent speculative arbitrage.
The revived old currency would effectively be made of two components: a commercial currency and a financial currency. Euro creditors would undoubtedly suffer and reintroducing the local currency may, to some extent, be considered as a "soft default", albeit one carrying limited uncertainty. On the other hand the country would suffer from an internal devaluation, hopefully of a more politically acceptable sort.
Inflation induced by the printing of new local money would need to be reined in, but today, deflation seems the greater evil.
In order to prevent a run on local banks by customers holding euro deposits, they would need to be reassured that their deposits would remain and be remunerated in euro, as if the local currency had not been reintroduced, a measure likely to require assistance from the eurozone. Barring convergence, a gradual and partial phasing out of the euro may naturally result in such an economy.
Implementing multiple exchange-rate mechanisms within the eurozone is no simple matter and won't cure the fundamental ills affecting Europe. Yet if maintaining the integrity of the monetary union is a condition necessary to prevent a dangerous political fragmentation and if troubled countries are to be given a chance, unconventional options such as running old currencies alongside the euro deserve serious consideration, and sooner rather than later.
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