Variant Perception: A Primer on the Euro Breakup

You may have already noticed that this one has been going the rounds. The piece is mainly driven by my colleague Jonathan Tepper's work on the history of currency union breakups and how they work (or don't). 

It is a big piece in its entirety but the different sections can be read as standalone arguments. The summary is pasted below.  

Many economists expect catastrophic consequences if any country exits the euro. However,during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises. Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable. Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).

Whether it would be as easy as earlier episodes of currency breakups to dismantle the euro zone is a highly contentious issue. I am not sure that I believe it would be as easy is implied in the piece. But this is not the most important point. We are now in a situation where a breakup or a division of the euro zone into two is no longer a remote theoretical discussion. To this end I think the piece takes up (and describes the mechanics of) some very important processes and issues. Go read! 

Comments

[farmland investment]

As a Brit who reads the Daily Telegraph regularly, I think that is way too optimistic. Think about the shear amount of legal contracts that will need to be unwound, it will be like a full employment law for barristers and lawyers. And then also imagine what would happen in advance. People from the PIGS countries will of course understand that their new currencies will plunge like a rock against the hard currencies in the North - there would be riots and desperate efforts to withdraw money from banks and buy gold or physically drive to Germany with cash to open bank accounts. Currency controls, border closures, it would be a nightmare.

[cv]

Thanks for the comment ... you may be right, but if anyone thing staying in will avoid riots and adverse social outcomes I think they are going to be very wrong (indeed they already are). As for the legal nightmare I think it is important to understand the mechanics of a wholesale default. Any euro asset in Greece would be automatically converted at the given exchange rate into new drachmas and this would happen together with a 100% capital control enforcement. This would then translate into a full scale default of Greek economic agents, but this is what we are already seeing in slowmotion.

Claus