Euro exits are the least bad option for the periphery
MOST economists expect catastrophic consequences if any country exits the euro. Like most conventional wisdom, such a view will be contradicted not by opposing ideas but by the march of events.
If the euro broke up, it wouldn’t be the first currency union to come apart. Within the past 100 years, there have been 69 currency break-ups. Astonishingly, almost all of the exits from a currency union have been associated with low macroeconomic volatility. In almost all cases, the transition was smooth and relatively straightforward.
Historical examples provide a roadmap for exit. The problem in Europe is that peripheral countries face unsustainable imbalances in real effective exchange rates and very high external debt levels. Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable.
European politicians don’t want to contemplate the end to their ambitious economic project. However, Greece and Portugal, and perhaps Spain, Ireland and Italy will ultimately conclude that it’s in their best interest to exit.
The move from an old currency to a new one can be accomplished quickly and efficiently. All local money and debt would be redenominated into a new currency. Typically, before old notes and coins can be withdrawn, they are stamped in ink or a physical stamp is placed on them, and old unstamped notes are no longer legal tender. In the meantime, new notes are quickly printed. Capital controls are imposed at borders in order to prevent unstamped notes from leaving the country. This entire process isn’t easy but it can be accomplished in relatively simple and transparent steps.
Defaults and debt restructuring should be achieved by exiting the euro, re-denominating sovereign debt into local currencies and forcing a haircut on bondholders. Almost all sovereign borrowing in Europe is done under local law. This would allow for a re-denomination of debt into local currency. Devaluing and paying debt back in drachmas, liras or pesetas would reduce the real debt burden.
Countries that have defaulted and devalued in the past have experienced short, sharp contractions followed by very steep, protracted periods of growth. The Eurozone periphery is likely to be different though. Rapidly ageing populations and structural government overspending mean that root and branch reforms are needed. However, such reforms are impossible in the current regime.
The best way to promote sustained growth in the European periphery can be summarised by the three Ds: depart, default and devalue. This would allow periphery countries to emerge from the crisis with clean balance sheets and more competitive exchange rates. If history is a guide, exiting the euro may be the best chance European periphery countries have to heal themselves
Jonathan Tepper is the co-author of Endgame, chief editor of Variant Perception and a Wolfson Economics Prize finalist.