I have long believed that the only real solution to the Euro crisis, barring a fiscal union which Germany so staunchly opposes, is to publically announce a mechanism whereby countries can leave the Euro in an orderly and negotiated fashion. This would diffuse the crisis’ most volatile element: the market uncertainty arising from the potential domino effect of defaults and Euro exits. As I’ve argued on more than one occasion, a Greek collapse matters little in the grander scheme of things. It’s the uncertainty over how European institutions would handle a Euro exit that generates the potential for contagion to other countries that indeed matter, like Spain or Italy which by virtue of their size are capable of breaking the union should they end up in Greece’s sandals.
Blasphemy say the Eurocrats! Such a mechanism is an implicit acknowledgement that the union has failed and there’s no legal basis for it anyway. Plus, you don’t just walk out of your family do you? Well, actually you do if your family is completely dysfunctional and the house is burning down in front of your very eyes. This is the unfortunate position that Europe once again finds itself in, barely a few months after a series of measures had led many to believe that the crisis had been “solved”. The first was the ECB’s bond buying programme in late 2011 and early 2012 which brought Italian yields back to stable levels (they had hit 7% for a while). The second was the fiscal compact agreed by 25 out of 27 countries in which they agreed to abide by certain fiscal rules or else face an empowered EC now able to dish out punishment. The third was the second Greek bailout, accomplished only negotiating a bond swap with private bondholders. Problem solved? Not.
It’s uncertainty, stupid
What stuns me the most is that the Eurocrats have not yet woken up to the fact that markets are scared of uncertainty more than anything else, and this uncertainty is being fed by the lack of an exit option to Euro membership. I won’t dwell on the legal elements since I’m not a lawyer, nor am I an expert on the history of the creation of the Euro (which we would now be effectively reverse-engineering) so I will leave the details to other more capable minds. What I can say is that at the very least, an exit mechanism should be constructed in such a way that it convincingly answers the following questions. 1) What will be the timeline for implementation, from when the exit is announced to when the country’s economy is fully operational in its new currency? 2) How will authorities prevent a run on local banks before the new currency devalues? 3) Will there be an attempt to swap Euro-denominated debt after the new currency devalues (implying bondholders will take another haircut)? 4) Will the country still be part of the EU?
The last question seems almost superfluous but it isn’t. Even if a country leaves the Euro, it should be allowed to remain in the EU if only to continue reaping the benefits of the common market. Also, well established EU frameworks on trade and investment will guarantee some level of confidence in the country. As for the other questions, all cards should be on the table, no matter how fanciful and outlandish. Perhaps the country could operate a dual currency system for a time. Perhaps the ECB could guarantee some degree of liquidity in order to attempt a gradual devaluation rather than a sudden one. The time for conventional responses to an unconventional crisis is over: just like the creation of a single currency was an unprecedented economic experiment, so will be the process of extracting a failed economy from it in order to keep both alive.
No more brinkmanship
The current strategy of averting an impending collapse of the Eurozone has been sustained by German brinkmanship, using the principle of least effort in order to avoid that which the German political class and its population wish to avoid at all costs: a fiscal union which would inevitably involve funds from the core (Germany) propping up the periphery at least until their productivity and competitiveness catch up. This could take decades – if at all – which lends some credence to the idea that the single currency is doomed in the long run, no matter what happens in the next few months. But to solve the market crisis, whose ugly head has reared up every few months almost like clockwork, you have to kill what’s feeding the panic: uncertainty. And the only way to do that is to propose a convincing mechanism for a Euro exit. On the positive side, some European authorities appear open to at least discussing the possibility. Sadly, they are still the minority and a non-politicized debate of this issue appears unlikely for now.
Failure to do so will just set the stage for one more flare up of market panic next time another fiscal austerity target is not hit, another GDP or employment figure underperforms, or another election brings to power a party sick of sticking to Germany’s guns. This can’t go on forever. If Europe was a cat, it had better start tracking how many of its nine lives it still has left.