Barry Eichengreen, author of the National Bureau of Economic Research paper “The Breakup of the Euro Area“, explains why joining the eurozone currency union is essentially irreversible.
No matter how much some may want a nation to leave the euro, the cost of leaving is just too great now. Just preparing for a euro-exit would trigger the ‘mother of all financial crises’ according to Mr. Eichengreen writing at VOX EU:.
The economic costs:
‘A country that leaves the euro area because of problems of competitiveness would be expected to devalue its newly-reintroduced national currency. But workers would know this, and the resulting wage inflation would neutralise any benefits in terms of external competitiveness. Moreover, the country would be forced to pay higher interest rates on its public debt. Those old enough to recall the high costs of servicing the Italian debt in the 1980s will appreciate that this can be a serious problem.’
The political costs:
‘A country that reneges on its euro commitments will antagonise its partners. It will not be welcomed at the table where other European Union-related decisions were made. It will be treated as a second class member of the EU to the extent that it remains a member at all.’
The infrastructure adjustment costs:
‘Reintroducing the national currency would require essentially all contracts – including those governing wages, bank deposits, bonds, mortgages, taxes, and most everything else – to be redenominated in the domestic currency. The legislature could pass a law requiring banks, firms, households and governments to redenominate their contracts in this manner. But in a democracy this decision would have to be preceded by very extensive discussion.
And for it to be executed smoothly, it would have to be accompanied by detailed planning. Computers will have to be reprogrammed. Vending machines will have to be modified. Payment machines will have to be serviced to prevent motorists from being trapped in subterranean parking garages. Notes and coins will have to be positioned around the country. One need only recall the extensive planning that preceded the introduction of the physical euro.’
The market costs:
‘Market participants would be aware of this fact. Households and firms anticipating that domestic deposits would be redenominated into the lira, which would then lose value against the euro, would shift their deposits to other euro-area banks. A system-wide bank run would follow. Investors anticipating that their claims on the Italian government would be redenominated into lira would shift into claims on other euro-area governments, leading to a bond-market crisis. If the precipitating factor was parliamentary debate over abandoning the lira, it would be unlikely that the ECB would provide extensive lender-of-last-resort support. And if the government was already in a weak fiscal position, it would not be able to borrow to bail out the banks and buy back its debt. This would be the mother of all financial crises.’
Thus the market effects of an exit from the euro-zone are the main challenge. A eurozone exit can’t be done overnight since a lot of preparationg would be required. Hence the argument is that markets would push an exiting nation into financial crisis as they tried to trade ahead of the euro-exit. Thing is, does this only apply to financially-weak Eurozone nations? What about nations that might be far better off outside of the eurozone, such as Germany? We feel a nation such as Germany might be able to avoid the negative market effects described above.
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