The euro: no soft landing on exit

By Jean Pisani-Ferry 12 September 2011 A version of this column was also published on Le Monde It may appear pointless to switch to summer time each year when it would be simpler for everyone to decide to come into work one hour earlier in the morning. Yet we all change the clocks because it is much easier to put back your watch than to change your habits. One hears this same rationale increasingly often for arguing that the countries whose competitiveness has nosedived should leave the euro. Rather than hoping that, by the combined effect of tens of millions of independent decisions, firms and workers would force themselves painfully to absorb past price and wage inflation, it would, according to some, suffice to recoup competitiveness by reducing the exchange rate of the new national currency by the requisite percentage. Monetary experience in fact teaches that, for the same final result, an internal devaluation (by a change in prices and wages) is much harder to achieve than a devaluation of the exchange rate. But, even if one disregards the European political stakes of such a decision, this logic sins by omission on several counts. The first obstacle is legal. The EU Treaty provides for a voluntary exit clause from the Union, but not from the euro. Thus a state may leave the Union (and thereby forfeit regional aid, considerable for Greece and Portugal, and CAP transfers), but there is no provision for leaving the euro and remaining in the Union. The second obstacle is technical. It is straightforward to change currency in a financially underdeveloped country: just order a stock of brand new notes. But it is quite another matter in a modern economy. Years of preparation and adjustment of IT systems went into the switch to the euro, followed by a lengthy test phase. Leaving the euro abruptly would inevitably be costly and disruptive. The third obstacle is economic. The proponents of exit claim that a controlled devaluation of the new currency is to be anticipated. This is to overlook that the countries likely to go for this option are labouring under a credibility gap. If there are new national currencies, it is the market which will determine what they are worth. When Argentina severed its fixed link to the US dollar in January 2002, the government announced a new exchange rate of 1.4 pesos to the dollar (instead of one peso). In July, there were four pesos to the dollar: the currency had lost three quarters of its value. A drop of three quarters in the exchange rate, surely, guarantees an ultracompetitive economy. But it would imply a quadrupling of the price of imported goods, which would not only impoverish consumers hugely but would prevent firms from acquiring equipment and semi-finished products. This is not the route to kick-starting exports again. The fourth, and toughest, obstacle is financial. Thinking in terms of competitiveness, inflation and purchasing power is to ignore the lending and borrowing of households, firms and the state, which are today denominated in euros. While commitments between residents of one and the same country could easily be redenominated in the new currency, this would not be the case between residents and non-residents. Bear in mind that, according to Claire
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Waysand and her colleagues at the IMF, lending and borrowing of the euro countries between each other currently amounts to 200 percent of GDP. Greek sovereign bonds held by French and German banks, the subject of much concern, are but part of a much wider web of potential problems. Firms, banks and insurance companies would see some parts of their balance sheet remaining in euros and others suffering a sharp drop in value. Some would gain from this, others would immediately go bankrupt. It would mean that fortune or ruin would be decided as if by the spin of a wheel. Moreover, as exit is not provided for in the treaty, it could not occur overnight. Depositors would have ample time to withdraw their money from banks, and banks would have time to borrow from their central bank in order to invest in countries remaining in the euro. This cautious behaviour would only deepen the disaster. Given the torment which Greece is facing at the moment, it will become ever more tempting to go for an alternative. But the option of an exit with a soft landing is a fiction. If by any chance this were to happen, there would be chaos. It would be economically destructive, financially ruinous and socially devastating.

Bruegel 2011

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