There’s widely divergent opinions among the experts regarding what would happen if Germany and other creditworthy economies like the Netherlands were to exit the eurozone to set up a new currency. The current issue of the Economist succinctly summarizes these differing points of view.
The dilemma for Germany, says David Marsh, an historian of the euro, is that there is now an agonising trade-off between being European and achieving the country’s cherished goal of economic and monetary stability. Even so, he does not expect Germany to break away. Its political class remains resolutely pro-European. The ruling CDU party is proud of its heritage as a European party; the opposition parties favour solutions like Eurobonds. More to the point, policymakers who have repeatedly bailed out Greece (2.5% of euro-zone GDP) for fear of the consequences of default will surely be petrified of the impact of a wider break-up.
Barry Eichengreen, a monetary historian at the University of California, Berkeley, says that the economic costs of disintegration would be catastrophic for Europe and beyond. In the case of Greece, he fears the result would be a 1930s-style Depression brought about in particular by the collapse of the financial system. If Germany were to leave, its export-based manufacturing economy would take a body blow as the new currency soared. Other costs are incalculable because much would depend on responses that cannot readily be modelled: a Greek exit, say, could spark bank runs in other peripheral countries.
Not everyone accepts these dire warnings. Daniel Gros of CEPS, a think-tank in Belgium, thinks that the impact on other vulnerable countries of a Greek exit could be contained as long as European leaders made clear that they would be protected. Charles Calomiris of Columbia Business School argues that Greece could ultimately benefit by leaving because it would bring about both the harsh default needed to restore debt sustainability and the big devaluation needed to restore the country’s competitiveness. As for Germany, it has a knack of coping with a high exchange rate.
In the Economist’s opinion,
Fear of the consequences of break-up is the strongest reason why fiscal union seems a more probable outcome than a fragmentation of the euro. But Europe’s institutional and political capacity to take bold decisions in a crisis is feeble. That is why the immediate focus of debate is on how to gear up the EFSF [European Financial Stability Fund] so that even with its limited resources it could do more.
What should be done with the EFSF?
The facility should be turned into a bank, say Mr Gros and Thomas Mayer of Deutsche Bank. It could then do a lot more by borrowing from the ECB to finance its activities. An alternative suggestion, from Mr Wyplosz, is that the ECB issues guarantees for sovereign bondholders. These warranties would be partial, but they would put a floor on potential losses. Another option is for the EFSF to offer investors protection against a first loss on bonds, and for the ECB to provide those investors with cheap, non-recourse loans. Euro-zone leaders decry the financial engineering that sparked the banking crisis. They are coming to appreciate its merits.
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