Lira: Spain’s Euro Exit Must Be Done In Secret or the Banking System Will Collapse Instantly

How Spain could exit the eurozone—a practical guide.

In late 2001, while everyone was in shock over 9/11, the Argentines were going through a little shock of their own: The “Corralito”.

Argentina was bankrupt, a product of a stagnant economy, rampant crony-corruption, and—most important of all—of having its currency fixed to the dollar. This currency peg had created a huge credit bubble, and of course massive capital outflows as a result, eventually leading to the depletion of foreign reserves by the government and an inability to raise more funds on the open markets.

In other words, sovereign bankruptcy.

Coupled to these problems, in the months leading up to the December 2001 crash, people were aware that the country was going bankrupt—so they were quickly converting all their Argentine pesos into dollars, and then sending this money to safe havens overseas.

To solve these problems of sovereign insolvency and massive capital flight, and at the same time to stabilize the situation, on December 1, 2001, the Argentine government imposed the infamous corralito—literally, the “little bullpen”: A series of measures designed to hold in capital and prevent it from fleeing the country, while devaluing the currency to a more realistic, sustainable rate of exchange.

As part of the corralito measures, the Argentine government froze all dollar-denominated bank accounts; converted those dollars into Argentine pesos on a one-to-one basis—that is,confiscated people’s dollars; limited all withdrawals in Argentine pesos to a weekly maximum of AR$250 (you read right: per week); and of course—the cherry on the sundae—it devalued the Argentine peso against the dollar.

The devaluation was at first a “mere” 40%—but shortly thereafter the Argentine peso was allowed to float: And it dropped to a rate of four to one against the dollar.

Literally millions of people lost their life-savings in one fell swoop. The local equity market tanked catastrophically, as did the local bond markets. People on a fixed income also got clobbered, as their pensions lost their purchasing power by 40% overnight—and then eventually by 75%.

Chaos ensued.

Now, the situation in Europe today is virtually identical to that of Argentina in 2001: Overleveraged, with an insolvent banking sector, a flatlining economy and growing unemployment.

But of all the countries, Spain in particular is the biggest trouble.

Spain today has a stagnant economy: 24% unemployment, 53% youth unemployment, an economy shrinking at an annualized rate of at least –1.75%, a banking sector with a collective insolvency that runs some €78 billion, a government that needs €190 billion this year alone to fund itself (on a total GDP of barely €1 trillion)—

—and most important of all: Spain has a looming inability to meet its debt payments, coupled with a rapidly deteriorating reputation among bond buyers.

In other words, Spain today is the Argentina of 2001.

Now, as I’ve written here before, the euro is essentially one giant currency peg: Monetary union over the past ten years meant that all the eurozone economies have pegged their currencies to the German currency.

During boom times, this meant that all the peripheral eurozone members enjoyed access to cheap and limitless credit—which they of course took advantage of. But during down times—like now—those debts become insurmoutable—like now.

I argued last week that Spain would leave the eurozone, probably before the end of the year. But the issue is, What would that exit look like? How would that exit be carried out, on a practical basis?

Let’s assume that the decision has been taken by Spain to exit the eurozone. Let’s further assume that on the day of the exit, Spain will initially value the New Peseta (NP$) at par with the euro—but that a devaluation will happen immediately thereafter, of say 30%.

Before anything else, the Spanish government would have to make sure that nobody—and I mean nobody—knew that the decision had been made until after the decision had been implemented.

Foreknowledge of a Spanish exit of the eurozone and a return to a local currency would cause a bank run of staggering proportions: People would realize that the government was going to devalue the currency, so they would rush to their banks to withdraw their euros and either send this money out of Spain or else hold it in cash under their mattresses. Either way, such a bank run would crater the entire banking sector instantly—because the banks certainly do not hold reserves to meet such a run.

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