C&B Notes

Is Finland Telegraphing Its Next Move?

Finland is one country publicly discussing plans about feasible ways to exit the euro currency union, including concurrently having two currencies: 1) the euro and 2) an active markka (Finland’s currency prior to the euro) that would be pegged to the euro for some period of time.  It appears that this is more contingency planning than a clear signal that the country would like to exit the currency regime.  This exercise does further highlight, however, the complications of leaving the eurozone even if done from a position of strength.

They would do well to keep watching another tiddler: Finland.  For while Finland has not created much drama, precisely because it is one of the strongest eurozone members, some fascinating discussions are under way.  Most notably, as the eurozone crisis rumbles on, some Finnish business and government officials are quietly mulling the logistics of leaving the currency union.

Nobody in Finland expects this to happen soon, if ever; indeed, most policy makers are strongly opposed to the idea.  Particularly since many also hope the crisis is dying down, but as Heikki Neimelaeinen, chief executive of the Municipal Guarantee Board says:  “We have started openly discussing the mechanism of euro exiting, without indicating that we will initiate such a process.”

* * * * *

Take a look, for example, at a recent research paper from Nordea, the Nordic bank.  This paper looks at the question of what might happen if Finland ever decided to run a so-called “parallel currency” system.  The idea behind this, as Nordea explains, is that at times of stress it can sometimes seem beneficial for countries to maintain more than one currency unit.  Most notably, if a country is trying to leave one currency, keeping that as legal tender alongside a second currency for a period can ensure a country honors its old contracts and thus avoids a technical default…

Most notably, under that scenario “of strength” the Finnish central bank could effectively let consumers and customers choose which currency they preferred to use.  “Euros will not automatically be converted into markka; all deposits, debt and agreements will remain in euros until the depositors transfer their deposits to markka-denominated accounts and the parties to the agreements amend their contracts,” Nordea writes.  It adds that, “during the transition period, the Bank of Finland will offer to exchange euros and markkas at a rate of 1:1 both ways.”  Only later would the markka float against the euro; and the latter could theoretically remain legal tender.  Whether Finns would choose to convert their euros, in this theoretical scenario, would depend on where they think that markka is heading.  Right now, most investors would expect it to jump.  After all, during the past year Finland has been viewed as a haven.  If that continued, it might “lead to a mass movement of investors, which will strengthen the currency more than warranted by the situation of the real economy.”

But it is possible to imagine an alternative scenario. Prior to the past decade, Finland experienced periods of financial instability, and the tiny size of any new markka-denominated market might also prompt capital flight.  “A significant proportion of the money invested in Finland during the euro era comes from investors who have been looking for safe euro-denominated investments and are not willing to carry the exchange rate risk associated with a small fringe currency,” Nordea notes.  “If foreign investors leave … the liquidity of Finnish markka-denominated listed equity and bond markets will decrease, risk premiums will increase and high fluctuations in prices will become more frequent.”