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2012-04-10 10:00:21
Charlemagne
Apr 7th 2012 | from the print edition
THE Irish left the sterling zone. The Balts escaped from the rouble. The Czechs and Slovaks left each other. History is littered with currency unions that broke up. Why not the euro? Had its fathers foreseen turmoil, they might never have embarked on currency union, at least not with today s flawed design.
The founders of the euro thought they were forging a rival to the American dollar. Instead they recreated a version of the gold standard abandoned by their predecessors long ago. Unable to devalue their currencies, struggling euro countries are trying to regain competitiveness by internal devaluation , ie, pushing down wages and prices. That hurts: unemployment in Greece and Spain is above 20%. And resentment is deepening among creditors. So why not release the yoke? The treaties may declare the euro irrevocable , but treaties can be changed. A taboo was broken last year when Germany and France threatened to eject Greece after it proposed a referendum on new bail-out terms.
One reason the euro holds together is fear of financial and economic chaos on an unprecedented scale. Another is the impulse to defend the decades-long political investment in the European project. So, despite many bitter words, Greece has a second rescue. Its departure from the euro, Angela Merkel, Germany s chancellor, now says, would be catastrophic . Yet Mrs Merkel is not ready to take the action needed to stabilise the euro once and for all. Last week s decision to boost the euro s firewall to 800 billion ($1.07 trillion) is less than meets the eye; the real lending power will be 500 billion. And there is no prospect, for now, of mutualising any part of the sovereign debt.
So the euro zone remains vulnerable to new shocks. Markets still worry about the risk of sovereign defaults, and of a partial or total collapse of the euro. Common sense suggests that leaders should think about how to manage a break-up. Some may be doing so. But having described a split as bringing economic Armageddon, leaders dare not be seen planning for it.
Instead, the most open thinking is being promoted by a British think-tank close to the Eurosceptic Conservative Party. This week Policy Exchange announced a shortlist of five contestants for a 250,000 ($400,000) prize for the best plan to manage a break-up of the euro. It may be a sign of the magnitude of the task that the organisers did not declare a winner; instead they asked those on the shortlist to do more work and resubmit their ideas. (A cartoon produced by an 11-year-old Dutch boy won a 100 voucher.)
One of the five entries, by Jonathan Tepper, lists 69 currency break-ups in the past century. Most have not led to long-term damage, he says. In fact, leaving the euro would help troubled countries recover quickly. Drawing on the demise of the Austro-Hungarian empire, among others, Mr Tepper sketches out a scenario for the departure of the likes of Greece. A surprise announcement is made over a weekend, and all deposits are redenominated in new drachmas while banks are kept shut. Capital controls are imposed to prevent the flight of money abroad. For cash, Greeks at first use existing euro banknotes defaced with ink or a stamp. These are withdrawn as drachma notes are printed. Border checks restrict the export of unstamped euro notes. Financial institutions are given time to update software.
The real problem with the euro, says Mr Tepper, is the fact that many countries face large imbalances and high debts. Devaluation for Greece would increase the burden of euro-denominated debt. This would be alleviated by converting bonds issued under Greek law to drachmas. Foreign-law bonds would be restructured. Indeed, says Mr Tepper, default is essential to recovery.
His formula might be summed up by three Ds: depart, default and devalue. Roger Bootle, another shortlisted entrant, says it might be better to start with the departure of Germany and other strong countries. But however it happens, any fragmentation will create winners and losers, with many bankruptcies and legal nightmares. Anybody involved in cross-border activity will find that their assets and liabilities change value. Neil Record says the sums involved would be so large, and the litigation so ruinous, that the best option would be to abolish the euro as soon as one country leaves, so as to invalidate all euro contracts.
Unlike Mr Record, who favours secrecy, in their paper Jens Nordvig and Nick Firoozye argue that open contingency planning would reduce uncertainty. They reckon there may be a total of 30 trillion-worth of cross-border exposure under foreign law, including bonds, loans, derivatives and swaps. Disruption, they say, could be minimised by converting all euro contracts to a modified form of the European Currency Unit, the basket of national currencies that preceded the euro. Catherine Dobbs, the final entrant, proposes to unscramble the omelette by splitting the euro into two (or more) zones: yolk and white . All euros in all countries would be converted into a fixed combination of the two. Savers would be protected, initially at least, and capital flight to other euro-zone countries would be deterred. Over time, the weaker yolk would devalue against the stronger white.
Plan ahead
The fate of the euro will probably be determined by politics as much as economics. A debtor state may tire of internal devaluation. A creditor may want to stop supporting others. And any one of the euro s 17 members may balk at the loss of sovereignty involved in saving the currency. But the worst outcome of a euro split would be a chaotic breakdown. An orderly process increases the chance that it might be possible to salvage from the wreckage other gains of European integration, notably the single market.
So euro-zone governments need to think the unthinkable. No self-respecting general would refuse to plan for a predictable war, no matter how much he dislikes the idea of fighting it.