The catastrophe that is Greece that has spawned the term 'Grexit' for its likely self-abdication (or dismissal) from the Euro remains a long way from being solved. Should the next elections go the way the opinion polls suggest, it seems highly likely that a government vehemently opposed to its own bailout terms and further austerity will stretch the patience of its 'core'-supports to a breaking point - even though they know the gun they hold is squarely pointed at their own forehead. However, Deutsche Bank's economics team see the potential for a third path - that of running a Greek parallel currency to the Euro (which they dub "GEURO") to represent government issued IoUs to meet current payment obligations. This would enable, in DB's view, Greece to engineer an exchange rate devaluation without formally exiting the EMU. With Greece unlikely to meet primary budget surplus targets envisaged by the TROIKA, and political will inside Greece hardly making an effort to do so - perhaps this is the 'compromise' that meets everyone's needs (in a strange way). Initially there would be a large depreciation (which Germany could use politically to claim - see 'they suffered' - and maintain circular support for the financial system implications of GREXIT) but at the same time Greek authorities would reclaim some semblance of control to stabilize or even strengthen (over time) their own GEURO against the Euro - leaving the door open to a return to the Euro at some point.
Recent opinion polls suggest that a new Greek government will be dominated by parties rejecting the Toika-led adjustment programme. In our view, however, the IMF and other euro area countries are unlikely to give in to pressure from Greece for a de facto end of the programme. The precedent of such an accommodation could lead to an erosion of adjustment efforts in other countries and eventually political pressure in Germany for EMU exit.
At the same time, however, Greece is unlikely to formally leave the euro, nor are the other euro area countries likely to abandon Greece entirely. The path of least resistance could be the stop of financial assistance to the Greek government and the continuation of payments for debt service and the stabilization of the Greek banks in a European “Bad Bank”.
In this case, a Greek parallel currency to the euro (which we dub the “Geuro”) could emerge when the government issues IoUs to meet current payment obligations. This would also allow Greece to engineer an exchange rate devaluation without formally exiting EMU. Initially we would expect a large depreciation, but the Greek authorities would have the power to stabilize or even strengthen again the exchange rate of the Geuro against the euro via prudent fiscal policy and structural reform so as to keep the door open to a future return to the euro.
Of course - this could enable Germany (or TROIKA) to maintain their financial assistance in a circular - we-give-you-money-to-fund-your-existing-obligations-to-us manner - while Greece uses the GEURO to manage its internal spending...
There would now be two parallel currency circuits in Greece: the euro circuit and the Geuro circuit. The former would be sustained by the euro deposits of and credits to companies in the export sector. After its initial shrinkage due to the emergence of the Geuro, the euro circuit would grow again on the back of the higher euro revenues of the export sector following its improved competitiveness. The Geuro circuit would be fed by Geuro issuance of the government to fund its primary budget deficit. It would then be in the hands of the Greek government to reduce the issuance of new Geuros by shrinking its primary deficit and thus to stabilize the exchange rate of the Geuro against the euro.
Thus, if reason prevails, Greece could formally remain in EMU, execute the exchange rate devaluation necessary to regain international competitiveness, and in the future decide for itself through issuance of Geuros, whether and over what time span it would want to return to a hard currency that is stable against the euro. It could eventually even return completely to the euro by repurchasing Geuros against euros.
The path of least resistance could be the stop of financial assistance to the Greek government and the continuation of payments for debt service and the stabilization of the Greek banks in a European “Bad Bank”. In this case, a parallel currency to the euro could emerge, allowing Greece a devaluation of its exchange rate without formally exiting EMU. It would be in the hands of the Greek authorities to stabilize the exchange rate of the parallel currency against the euro via prudent fiscal policy and structural reform so as to keep the door open to a future return to the euro.