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8/2/2019 Developing Country Growth Assignment - Group 2 - The Wolfson Economic Prize
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The Wolfson Economic Prize:An assessment of the five finalistsMassimiliano Barone
Evren Karayel
Paolo Mentonelli
Sara Moreno Losada
Davor RogozThomas Richardson
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Table of ContentsIntroduction ........................................................................................................ 3
The Euro Crisis and the lack of an exit plan ............................................. 4Solution? ............................................................................................................. 6
Jens Nordvig and Nick Firoozye - Planning for an orderly break-up ofthe European Monetary Union. ..................................................................... 7
Roger Bootle Leaving the euro: A practical guide ................................ 10Neil Record - If member states leave the Economic and MonetaryUnion, what is the best way for the economic process to be managedto provide the soundest foundation for the future growth andprosperity of the current membership?....................................................... 12
Jonathan Tepper - A Primer on the Euro Breakup: Default, Exit andDevaluation as the Optimal Solution........................................................... 14
Catherine Dobbs The NEWNEY approach to unscrambling the Euro . 17
Is there a winner? ........................................................................................... 19
References ........................................................................................................ 21
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IntroductionThe Wolfson Economic PrizeThe Wolfson Economics Prize was created by Lord Wolfson to
challenge the worlds brightest economists to create a contingency
plan for the break-up of the Eurozone. On April 3rd 2012, the five
finalists were announced. They are:
1. Roger Bootle and team, Capital Economics2. Cathy Dobbs, private investor3. Jens Nordvig and Nick Firoozye, Nomura Securities4. Neil Record, Record Currency Management5. Jonathan Tepper, Variant Perception
This paper will present a short summary and a critical appraisal of
each of their proposals.
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The Euro Crisis and the lack of an exit planIn addition to the five finalists, the Wolfson Prize also published four
other submissions that it considered worthy of note. Charles Dumas
entry (Lombard Street Research) is one that was praised for its
analysis of the Euros problems and their roots. He is also quoted by
another entrant, Edward Hugh, as having described the Euro as a form
of suicide pact.
The Euro has always been a controversial project. Hugh highlights
Marty Feldsteins view that the Euro was always a political project at
heart, hence the broad ignorance of the macroeconomic objections by
those who championed its implementation. He highlights that its
possible breakup was already forecast by Garber (1998) and Scott
(1998).
Hugh also identifies the 5 key characteristics of an optimal currency
area (Labour mobility across entire currency area; degree of economic
openness; degree of trade interconnection; risk sharing and
rebalancing framework i.e. automatic fiscal transfer mechanism; and
harmonised business cycles), noting that only the condition of a strong
degree of trade interconnection really satisfied.
Other major problems include the Euros one size fits all monetary
policy, as the work of San Francisco Federal Reserve Economist
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Fernanda Nechio has observed: Using a simple Taylor Rule procedure
to analyse the suitability of the monetary policy decisions of the ECB
for the Eurozone core and its periphery she found that right from the
Euros inception the rate set was more in line with the needs of the
core.
Although the Euro survived its poor start (in terms of its dollar parity)
to become part of the natural and familiar furnishing of the global
financial architecture, when the global financial crisis hit in 2008 it
wasnt long until its sustainability was being questioned again.
The problem is made worse by the lack of an exit plan, because as
Stephen Deo at UBS (Deo et al, 2011) points out, referencing Hotel
California, it was intentionally set up so that once your country signed
up you could never leave.
The Europhiles and Eurosceptics have stuck resolutely to their original
positions, with the Europhiles straining to allocate all blame on the
global financial crisis and maintaining that the Euro must be saved or
there will be a global financial disaster, whilst the Europhiles, struggling
to avoid appearing smug at being proved right, are enraged further by
the fact that the mainstream politicians still ignore their warnings.
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Solution?Of the five finalists, Catherine Dobbs best summarises what a good
exit path from the Euro must achieve, in the form of seven tests that
it should pass:
1. Does the approach provide clarity on how Euro denominatedcontracts, assets, liabilities and sovereign debts are
redenominated in the new multi currency regime?
2. How well does the approach result in matched treatment ofassets and liabilities (and supply and sales contracts) for
corporations, governments and individuals?
3. How can the migration pace and process be managed so as toprovide minimal disruption?
4. Does the migration treat individuals roughly evenly?5. How doable is the approach politically?6. What will be the impact of the exit on macroeconomic effects
including inflation, confidence and the effects of debt?
7. Does the discussion of an exit approach within the EU, in itself,result in destabilizing the Economic and Monetary Union?
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Jens Nordvig and Nick Firoozye - Planning for an orderlybreak-up of the European Monetary Union.Norvig and Firoozye establish two possible Break up scenarios: A big-
bang Eurozone break-up where the Euro will disappear and a
sequential or onion peeling break-up process where only the strong
core European countries will remain in the Eurozone. Whichever occurs
(they see the onion peeling option as unlikely as once it got to the
stage where Italy or Spain were the next layers, the size of their
economies would make the big-bang inevitable), they see the key to
a successful break-up will be how the various debt contracts are dealt
with according to the various areas of legal jurisdiction.
1st Scenario: Individual exit of countries Obligations issued under local law, it is highly likely that
redenomination into new local currency would happen through a
mandatory currency law (regardless of the nature of the breakup).
Obligations issued under foreign law - a more complex situation.o
Unilateral withdrawal and no multilaterally agreed framework
for exit, foreign law contracts are highly likely to remain
denominated in Euro.
o Exit is multilaterally agreed, the large majority of contractsand obligations are likely to stay denominated in Euro.
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2nd Scenario: Full blown Eurozone break-up - contracts cannot continueto be settled in Euros. Three solutions.
1. Obligations are redenominated into new national currency.2. Existing Euro obligations are converted into a new European
Currency Unit (ECU-2). (Eliminates the currency risk that from
arbitrary conversion rates decided upon by courts.)
3. Euro denominated obligations could in theory be settled inan international foreign currency, such as GBP or USD (NY
Law contracts).
The authors outline four key steps needed to facilitate an orderly
currency redenomination process:
1. Offer guidance on the redenomination process for local and foreignlaw assets.
a. Guiding principles for redenomination oflocal law assets:Each Eurozone country should redenominate assets and
obligations in accordance with a new currency law.
b. Guiding principles for redenomination offoreign law assets(high level of legal uncertainty) specifying a role for a new
European Currency Basket (ECU-2) to settle Euro
denominated assets and obligations.
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2. Specify the role of a new European Currency Unit (ECU-2) in theredenomination of foreign law assets and obligations.
3. The creation ofhedging market for intra-EMU currency risk, aimingto reduce intra-EMU currency risk, through the creation of non-
deliverable currency forward markets.
Allowing exchange and mitigation of the ongoing redenomination
risk would reduce systemic risk in the Eurozone banking system.
4. Adopt a new regulatory framework to reduce intra-Eurozonecurrency exposure and encouraging hedging of new FX exposures.
With the legal framework established, the key question is how would
the value of the ECU-2 be established. Their proposal would be for it
to be mechanically linked to the performance of the new currencies of
previous Eurozone countries and their equity weights in the ECB, with
the redenomination process mirroring how ECU-denominated
instruments were redenominated into Euros in 1999.
As many believe that policy makers got this wrong in the first place,
how could we guarantee that they would get it right this time?
However, the floating exchange rates of the new national currencies
should prevent any country experiencing a sustained advantage or
disadvantage.
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Roger Bootle Leaving the euro: A practical guideRoger Bootles Practical guide focuses on the question how an
individual country can effectively leave the Euro with minimal disruption
of its own monetary system. As Bootle sees the Euro as a
malfunctioning monetary union (due mainly to its political origins) he
believes that it is better for a country with high debt burden and
stalling economy to leave the monetary union, embracing the idea of
currency depreciation as a way of becoming more competitive.
Otherwise the country faces a disaster by likely debt default and
banking collapse.
If handled well, an exit could present weak peripheral members with a
much better prospect than remaining in the Euro. Moreover, their exit
could enhance the prosperity of the rest of Europe.
Therefore his essay aims to provide a practical step-through of the
issues around Euro exit. The central focus is how to achieve a fall in
real wages and prices with the minimum practical disruption and
proposes that government debt and consumer debt be redenominated
into euros deploying the lex monetaeprinciple. Meaning that each
country determines the currency applicable under its laws with foreign
courts consequently recognizing it.
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However, it proposes that corporate sector contracts be left to the
determination of legal courts (in a few cases contracts will be
interpreted in terms of national currency; in most in terms of the
Euro).
Bootle believes that there would be a large default on debt, which will
lead to reduction of the debt to GDP ratio to 60% for a country in a
similar situation to Greece, and the currency would depreciate or be
devalued.
The success of his proposal mainly depends on the success of its
execution. If the execution goes wrong, countries could face
hyperinflation and economic meltdown, which is a worse scenario than
staying in monetary union. Therefore the question is: which scenario is
more likely to happen - A Eurozone countrys default or its successful
exit from monetary union?
I think that most probable scenario for such countries e.g. Greece, is
defaulting first and then consequently exiting euro. Taking that into
consideration I think that all members should be given a chance to
use the euro until they default and then set up their own currencies
and consequently regain their monetary sovereignty.
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Neil Record - If member states leave the Economic andMonetary Union, what is the best way for the economicprocess to be managed to provide the soundest foundationfor the future growth and prosperity of the currentmembership?Record foresees an orderly and controlled Euro abandonment with a
guarantor country, namely Germany at the forefront and possibly
France as junior partner. The execution should be led by a Task Force
responsible for deciding the precise and quick actions to take and
should be presented to the Council of Ministers. Particular emphasis is
given to the secrecy of the whole operation.
Thus, in order to control the process, the Task Force should
recommend these main actions to undertake:
The Euro should cease to exist at the time of German exit andit should be replaced by a National currency. After the
announcement, the National currency would be represented by
the Euro notes identified with the relevant country code (X for
Germany). This would mean that all the euro banknotes with a
different prefix would become foreign currencies.
Define the exchange rates on the basis of reference points thathave been stable over the past years
Preserve the EU, by not imposing custom duties or any otherheavy form of commerce restriction.
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Replacing the ECB and all its functions with the National CentralBank (NCB).
The capitalization of the NCB should be done through two sources:
the shareholding proportion coming from the Balance Sheet of the
ECB and the support of the national government if the previous assets
injection would not suffice.
Overall, the issues are well developed and deeply analyzed, with useful
suggestions such as the idea of using the same Euro banknotes with
their prefix-codes as identification for the new national currencies, is
particularly helpful to solve the problem of the lack of an alternative
currency.
However, critical aspects would need to be better clarified, in
particular: the exchange rate definition, the inflation control, and the
liquidity of the banks.
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Jonathan Tepper - A Primer on the Euro Breakup: Default,Exit and Devaluation as the Optimal SolutionI've long said that capitalism without bankruptcy is like Christianity
without hell.om
Frank Borman, Chairman of Eastern Airlines
The paper written by Jonathan Tepper suggests than an orderly
default for euro zone countries bearing an unsustainable debt like
Greece, Spain, Portugal, followed by a subsequent exit from the Euro-
zone with concomitant devaluation of their currencies is the most
rational and beneficial way to improve the economic environment in
the EU.
Tepper bases his conclusions on detailed analysis of historical
currency exists which shows little macroeconomic volatility and, in the
majority of cases, also a fast recovery and growth for the respective
countries. Tepper suggests that the previous currency exits can be
used as roadmaps for current situation.
Furthermore, the paper provides an exact manual about how the
aforementioned countries and the in the Eurozone remaining countries
should react. As Tepper correctly highlights the most challenging part
of his scenario would be the redenomination of existing debt into a
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new currency. For this part he suggests redenominating the existing
debt, which was done under local law into a new currency, and
leaving the debt done under foreign law (other Euro countries) as
Euro-debt.
Unfortunately, one of the biggest weaknesses ofTeppers paper is that
he doesnt suggest any solution for private saver whose saving will
suffer the most in case of an exit from the euro-zone, as he also
correctly points out. While the rich and powerful will have already
transferred the majority of their savings abroad, the small savers will
suffer from this action and Tepper does not come up with a
suggestion to solve this problem.
Tepper highlights why a common currency is not possible for all the
European countries unlike in the US. He suggests that being in an
union where a country does not have to possibility to stamp money or
other sovereign tools to fight against crisis, leads eventually to
suffocation of weaker countries to the advantage of the stronger part
of the union. Furthermore, Tepper also demonstrates that some EU-
regulations like no deficit-runs are counterproductive in reducing the
existing debt highlighting regulatory problems in the euro-zone.
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In summary, Teppers paper contains many insightful explanations. It
suggests that the fear from Euro-exit is unfounded and in fact that it
is the only viable path to pursue. The paper would have been more
credible if he could have elaborated a little bit more on the fact how
the Eurozone would react now, given the fact that the size of the
countries involved and their interdependencies are much stronger than
any time in the history before. With the risk and fear of financial
contagion amongst the Eurozone, one could argue that the historical
currency exits are not comparable to its situation.
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Catherine Dobbs The NEWNEY approach to unscramblingthe EuroDobbs argues that a departure by any nation from the EMU would
result in a shock anywhere from five to ten times the size of the
shock generated by the collapse of Lehman Brothers in 2008. This
would result in another, more significant liquidity crisis and huge,
destabilizing capital flows away from the departing country(s). Dobbs
approach seeks to avert this scenario by removing the incentives for
such capital flows. The five key components of Dobbs plan are:
1) Treat all Euros as equal, regardless of location.2) Split the zone into two (or more) regions: the white zone whose
currency she calls New Euro White (NEW) and the yolk zone,
referred to as New Euro Yolk (NEY).
3) All existing Euros would be converted into a basket of NEW andNEY and an exchange rate versus the old Euro would be fixed.
4) Yolk (NEY) would slowly devalue its currency via interest rate
changes and inflation without causing a run on the currency
(inflation targets would be laid out and clearly signaled to the
market in advance).
5) Capital controls would need to be implemented and enforced toprevent movement (both electronic and physical) of assets away
from the NEY zone.
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The primary benefits of Dobbs approach are the following:
1) Automatic redenomination of Euro assets, contracts, and
liabilities.
2) Removes incentives for destabilizing, speculative capital flows,thereby reducing the likelihood that the plan will ever need to
be implemented.
Some drawbacks to Dobbs plan:
1) Expectations of targeted/future inflation may prevent a gradualdevaluation and probably cause wages to rise, making the
sought after gain in competitiveness more difficult to achieve.
2) Could dampen economic growth as borrowers get hit more thansavers due to rising interest rates.
3) New notes and currency would need to be printed/minted,something that would be difficult to accomplish in secret.
4) Capital controls might be difficult to enforce, especially wherethere are large, porous borders.
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Is there a winner?Catherine Dobbs highlighted an article published in the FT about the
Wolfson Prize by Tim Hartford, who described the competition as
impossible to win, but contrary to his expectations Lord Wolfson
does appear set to award the prize.
The entrants can be split into two groups: Dobbs and Nordvig focusing
on specific issues (regarding capital flight and Eurozone debt contracts
respectively), and the submissions of Bootle, Record and Tepper, who
focused on the lessons that could be learned from previous
devaluations and exits from currency unions.
Teppers faith that a Euro-exit would be just like the many previous
examples of currency devaluation is admirable, but we agree that the
unprecedented contagion risk as highlighted by Dobbs is too large to
be overlooked. Similarly the submissions of Bootle and Record depend
significantly on keeping plans secret from the markets. The chances of
this being possible are pretty small and the political ramifications once
the plans were revealed could be interesting.
Both Dobbs and Nordvig suggest creating a new currency to deal with
the issues they raise. As the judges commented when announcing the
finalists, Dobbs NEWNEY approach is beautifully clean, clear, concise
The solution is original, insightful, elegant and persuasive.
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It deals best with perhaps the most difficult of her 7 tests how
doable is it politically? It is delicately argued as being appropriate for
discussion and even being announced as the EUs official Plan B,
without causing any harm to the Euro itself. It also appeals to those
seeking the more capitalist solution as the mechanism rewards lenders
with high credit quality books gain (because there are fewer defaults)
and those with low credit quality book lose (because the defaults that
do occur involve larger haircuts).
The Nordvig solution is not as likely to be as appealing to the general
public as the mechanisms that underlie the ECU-2s valuation are more
complex and involve a hedging market, which would perhaps be a
difficult sell to the politicians and their electorate (bearing in mind the
proposal could be subjected to a referendum) in the current climate.
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ReferencesNechio, Fernanda. 2011. Monetary Policy When One Size Does Not Fit
All FRBSF Economic Letter 2011-18 (June 13)
Deo, Stephane, Paul Donovan & Larry Hatheway. 2011. Euro break up
the consequences, UBS investment research
Scott, Hal S.: When the Euro Falls Apart, Intl Fin 1:2, p. 207-228,1998.
Garber, Peter (1998), Note on the Role of TARGET in a Stage III
Crisis, NBER Working Paper no. 6619.