It appears that Germany may be awakening to the disaster that would follow the collapse of the eurozone. Der Spiegel has an issue explaining the disastrous effects on Germany. They divvied them into actual costs (of printing up and distributing a new currency), export collapses, unemployment, and a loss of international power. The article lumps in the problems for Germany’s banks in the unemployment section, which is fair enough: the problem with having Germany’s banks take massive losses on their lending to de-euroized countries is not that the banks would lose money. It is that the resulting increase in risk premiums would cause a credit crunch, drive illiquid-but-solvent firms to the wall, and kill jobs.
To be fair, it is much more likely that the euro would collapse as other countries peeled off in the wake of banking crises. So their first cost is a bit of a red herring, since even an extreme eurocollapse would certainly still leave a rump euro used by Austria, Finland, Germany, the Netherlands, Luxembourg, Slovenia, Slovakia, and (probably) France. That said, for Germany the costs of reintroducing would be small.
That is not true for the countries likely to decide to leave the single currency. They would face massive adjustment costs. My friend Doug thinks they can be avoided. He is right ... if the banking systems in those countries have already collapsed. If the banking systems have gone under, then abandoning the euro is all gravy. The new central banks can reflate and keep domestic depositors whole, while the inevitable fall in the value of the new currency triggers an export boom. There will still be legal issues, since the governments of the countries with collapsing banks will have already likely imposed de facto capital controls (at the very least, a bank holiday of sorts), and that is against European law.
But if the banking system is still alive, then the Eichengreen logic holds: the run-up to de-euroization would see the mother of all capital flight. Everyone and their second cousin tried to get their money out of the de-euroizing country. Yields on government debt would spike to impossible levels; likely debt auctions would actually fail. The result of that would be massive massive government cuts in the run-up: imagine workers paid in IOUs instead of cash. Finally, anyone with paper euros would hoard them, driving the economy back to barter. This all happened in Argentina.
The reason why I think the euro is now 50-50 is that I can imagine things getting so bad that leaving the currency would in fact have few costs, but I want to be clear: the reason that it would have few costs is that they would have already been paid, not that they would not exist. Only the benefits would remain.
If that is not correct, then I think there is an opportunity to make some money explaining why to the Irish, Greek, Portuguese, and Spanish governments. Over to you, Doug.
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