Is there an easy way out of the eurozone?

by on January 9, 2012 at 11:01 am in Economics | Permalink

Robert J. Barro writes:

Italy could have a new lira at 1.0 to the euro. If all the euro-zone countries followed this course, the vanishing of the euro currency in 2014 would come to resemble the disappearance of the 11 separate European moneys in 2001.

In the meantime, doesn’t every euro — a few sticky grannies aside — leave the Italian banking system?  Presumably the new lira is not pegged at 1-to-1 forever.  Switching out of lira/euros in Italian banks, before the inevitable depreciation, would offer a short-run rate of return of at least thirty percent, maybe more.  Or if such a peg holds, and can be enforced, and is seen as credible, isn’t it just like the euro?  (Do they deflate their economy by thirty percent or more to validate the exchange rate?)  The difference being, of course, that with a separately marked currency it would be easier for Italy to leave the eurozone, which is one reason why a 1-to-1 peg would not be seen as eternally credible.  I don’t see how this transition works; am I missing some segment of Barro’s argument?

By the way, the switch to the euro was easier for a few reasons.  People believed the national currencies would become stronger (certainly for Italy), not weaker, and there were few doubts about the solvency of various banking systems.  That said, the switch to the euro did give rise to unsustainable capital flows into the weaker countries and that is not working out well either.

George January 9, 2012 at 11:44 am

That is why only Germany (and Estonia or Finland) can leave the euro safely. Most other countries would suffer massive bank runs and capital flights, that will depreciate their currency enormously (not 5%, but probably 99.95%).
BTW, Italian lira had exchange rate of 1500 ITL per 1 USD in 1998!

zbicyclist January 9, 2012 at 3:32 pm

So, if we extend George’s thought we have this way to dismantle the euro??

1. Germany, Estonia and Finland leave.
2. Euro depreciates versus the dollar, yen, “mark”, etc.)
3. Next strongest countries leave the euro.
Lather, rinse, repeat.

dearieme January 9, 2012 at 12:17 pm

Soon enough someone will suggest that they leave, devalue their new currency vs the euro and then give it credibility by fixing it to the USD. Just you wait.

JWatts January 9, 2012 at 1:43 pm

You missed a step:
1) Decry harsh Anglo-Saxon capitalism.
2) Leave EU.
2) Gain credibility by fixing currency to USD (or possibly substitute pound or deutschmark)

question the question January 9, 2012 at 2:13 pm

Practice, practice, practice.

JP Koning January 9, 2012 at 4:24 pm

Barro’s is the Euro-as-glove argument. You can slip it on, and slip it off just as easily.

I like the Euro-as-Chinese-finger-trap argument. Once you’re in, you aren’t going to get out of it.*

*Germany can’t leave it easily, because it is owed some E500b by the ECB via the Target2 settlement system. Leave it and lose it. The PIIGS can’t leave, because as Tyler points out, a bank run will immediately result. And if they dodge the run, they surely won’t be able to dodge euroization: citizens will spontaneously disengorge any newly-created liras/drachmas/etc in favour of the already-circulating and vastly superior Euro.

George January 10, 2012 at 5:56 am

Germany will surely have capital loses – it is a creditor country that invested in many euro-denominated assets. But, the whole government and private debt of Germany is also in euro at the moment, so they also have huge liabilities in euro. So Germany can surely have some capital gains, if they leave existing liabilities in euro to depreciate (although that may also hit credibility of German government debt and banks).

James January 10, 2012 at 3:18 am

Rather than Italy, a strong economy should leave first. As long as the new currency is expected to appreciate relative to the Euro, there will be sufficient capital inflow into the currency before it is floated which will then drip out following liberalisation. This will effectively keep the exchange rates constant over the short to medium term, and negates the need to worry about the currency of bank deposits and loans. I’m not sure how the debts would play out in the longer term.

If Finland was strong enough, I would suggest the New Finnish Markka be the first to try it. However, in its current state with its highly regulated labour market, a welfare state that pays out to the rich and distorts labour market decisions, and no Nokia, I don’t suggest it is a strong contender for an appreciating exchange rate.

Jason Pappas January 10, 2012 at 10:38 am

A common currency isn’t the issue. Gold was once the common currency. Common credit is the problem. Not every government or firm is credit worthy. There’s no doubt in my mind that euro policies tacitly encouraged reckless lending to less credit-worthy governments. European banks are de facto GSEs executing the policy of the European Union and member nations.

Profligate governments normally would use soft default, i.e. pay back loans with worthless money. When the currency is out of one’s control, the only avenue is a hard default. The only question for Greece is which kind of bankruptcy is politically possible. Given the “voluntary” haircut on Greek debt, bankruptcy is already underway.

Barro argues that the old monetary system was better. Given the need for default, soft and gradual inflation has it merits: it is slow and less sharply painful. But that makes it more likely to be used. There seems to be some merit to the current situation. Greek governments can blame foreign entities for austerity. What they need to do is cut salaries instead of cutting jobs until labor clears (assuming they liberalize labor markets) … and blame the EU.

Floccina January 10, 2012 at 1:11 pm

Shouldn’t those countries with very low birth rates default on their debt? That would force them to balance their budgets but why borrow if in the future will have fewer people to pay it back.

J Mann January 10, 2012 at 2:59 pm

This is probably too obvious, but it seems like the solution is to exchange baskets of currency for the Euro.

1) In a total break-up, you’d get one Deutchmark, one Pound some number of shillings, 100 Lira, and so on.

2) In a limited break-up, you get a basket of one “New Euro” (good everywhere but Italy), and one Lira.

That way, every Euro holder gets a New Euro and Lira, not just the ones with deposits in Italy, so there’s no incentive to move Euro assets across European borders. (There may be some incentive to move into or out of Euro denominated assets altogether if there are any mistakes, of course).

Obviously, it’s more complicated than that, or someone would just point it out, but it seem like the least worst option.

J Mann January 10, 2012 at 3:01 pm

Oh, the issue is Italian denominated debt – i.e., after the breakup, are Italy’s bonds paid in Euros or Lira. Nevermind my prior post, then.

Swedo January 10, 2012 at 6:29 pm

All this talk about leaving the eurozone is utter nonsense. There is no way out.

Banks may implode, countries default and inflation run wild but the euro is not going away.

John David Galt January 10, 2012 at 11:04 pm

Assume Italy does try to permanently peg the New Lira 1:1 to the Euro using a currency board.

Argentina tried similarly to peg its peso 1:1 to the dollar. Does anyone seriously believe the result would be any different this time?

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