The euro is proving horribly costly for some. A break-up would be even worse
Dec 2nd 2010 | from PRINT EDITION
BOND markets have scorned the €85 billion ($113 billion) bail-out offered to Ireland on November 28th. Yields have risen not just for Ireland but for Portugal, Spain, Italy and even Belgium. The euro has fallen—again. As one botched rescue follows another, solemn vows from European Union leaders that a break-up of the single currency is unthinkable and impossible have lost their power to convince. And that is leading many to question whether the euro can survive.
The case against it is that European citizens can no longer live under its yoke. In Europe’s periphery some are yearning to be spared the years of grinding austerity that may be needed for wages and prices to become competitive. In the German-dominated core they are fed up with paying for other countries’ fecklessness and they fear that, as creditors, they will suffer if the European Central Bank (ECB) inflates away the laggards’ debts. Deep down lurks the sullen suspicion that this is a drama that the euro zone may be condemned to relive time and again. So why not get out now?
Financial history is littered with events that turned from the unthinkable to the inevitable with breathtaking speed: Britain left the gold standard in 1931, Argentina abandoned its dollar peg in January 2002. But a collapse of the euro would bring with it unprecedented technical, economic and political costs (see article).
A break-up might happen in one of two ways. One or more weak members (Greece, Ireland, Portugal, perhaps Spain) might leave, presumably to devalue their new currency. Or a fed-up Germany, possibly joined by the Netherlands and Austria, could decide to junk the euro and restore the D-mark, which would then appreciate.
In either case, the costs would be enormous. For a start, the technical difficulties of reintroducing a national currency, reprogramming computers and vending machines, minting coins and printing notes are huge (three years’ preparation was needed for the euro). Any hint that a weak country was about to leave would lead to runs on deposits, further weakening troubled banks. That would result in capital controls and perhaps limits on bank withdrawals, which in turn would strangle commerce. Leavers would be cut off from foreign finance, perhaps for years, further starving their economies of funds.
The calculation would be only slightly better if the euro escapee were Germany. Again, there would be bank runs in Europe as depositors fled weaker countries, leading to the reintroduction of capital controls. Even if German banks gained deposits, their large euro-zone assets would be marked down: Germany, remember, is the system’s biggest creditor. Lastly, German exporters, having been big beneficiaries of a more stable single currency, would howl at being landed once again with a sharply rising D-mark.
If the economics of pulling apart the euro look dubious, the politics risks detonating a chain reaction that would threaten the fabric of the single market and the EU itself. The EU and the euro have been Germany’s post-war anchors. If it abandoned the currency, at huge cost, and left the rest of the euro zone to fend for itself, its commitment to the EU would be in serious doubt.
If a weaker country left, risking not just European banks but also the currency, it would become a pariah exporting its pain to its neighbours. Once capital controls were in place Europe’s financial markets would be in tatters and it would be hard to preserve cross-border European trade. The collapse of the single market, which has done more than anything else to knit Europe together, would threaten the EU itself.
However much countries may now regret joining the euro, leaving it does not make sense. But the fact that it ought to survive does not mean that it will. And unless Europe’s leaders move further and faster, it might not.
Salvaging a single currency
Europe’s leaders have been slow and timid in response to market pressures. Greece and now Ireland have forced them, reluctantly, into bail-outs. Only belatedly have they recognised that some countries are not just in need of bridging loans to tide them over, but may be unable to repay their debts. That means that some pain will have to be inflicted on bondholders.
This will be easier to achieve now that euro-zone governments have agreed that sovereign-debt issues after 2013 should contain collective-action clauses, which stop hold-out investors blocking deals. The Irish have already imposed “haircuts” on subordinated-debt holders in their banks, though they were stopped from doing this for senior bondholders (see article). Such talk is inevitably unpopular in the markets. Yet losses must be possible if investors are to distinguish between sovereign-debt issuers.
The crisis should also have brought home to weak deficit countries the high cost of their failure to make the reforms to labour and product markets, and to welfare systems, necessary to restore their lost competitiveness. Even if they left the euro, they would have to take such steps to thrive. Within it, reform would not just revive moribund economies, but also create the chance of future growth to safeguard the single currency. Reform would be easier if surplus countries (ie, Germany) did more to boost their own domestic demand.
Lastly, if the euro is to survive, creditor countries need to give more aid to deficit countries. They could do this directly, or the ECB could provide liquidity to banks or buy up government bonds before they fall too far. It has indicated it may start doing the latter again. Germany hates the idea of more aid to debtor countries (see article)—hence its slowness to accept bail-outs and its determination to penalise bondholders. Its unwillingness to subsidise the weak and profligate is understandable; but the alternative is worse.
Breaking up the euro is not unthinkable, just very costly. Because they refuse to face up to the possibility that it might happen, Europe’s leaders are failing to take the measures necessary to avert it.