Sunday, February 19, 2017

Relax, Said the Night Man

Recently, Bloomberg published a Barry Eichengreen column headlined "Don't Sell the Euro Short.  It's Here to Stay".  He writes:
Two forms of glue hold the euro together. First, the economic costs of break-up would be great. The minute investors heard that Greece was seriously contemplating reintroducing the drachma with the purpose of depreciating it against the euro, or against a “new Deutsche mark,” they would wire all their money to Frankfurt. Greece would experience the mother of all banking crises. The “new Deutsche mark” would then shoot through the roof, destroying Germany’s export industry.

More generally, those predicting, or advocating, the euro’s demise tend to underestimate the technical difficulties of reintroducing national currencies. 
In the conclusion, he says "I argued that it is the roach motel of currencies. Like the Hotel California of the song: you can check in, but you can’t check out."   To be precise, that's true of the Roach Motel (see here, if you don't know what that's all about), but, according to the Eagles, you can actually check out of the Hotel California, though you can never leave (hmm... sounds kind of like "Brexit"...).

In any case, the fact it hangs together because eurozone members feel trapped by the costs of exit is hardly an affirmative case for the single currency.  In Greece's case, its hard to believe that the costs of exit really would have been higher than the costs of staying; this FT Alphablog post by Matthew Klein pointed out this figure from the IMF's Article IV report:
The IMF also released a self-evaluation of its Greece program, which Charles Wyplosz analyses in a VoxEU column.  See also: this Martin Sandbu column and this article by Landon ThomasMatt O'Brien's write-up of research by House, Tesar and Proebsting of the impact of austerity in Europe is also relevant.

The fact that the eurozone rolls on with no sign that a depression in one of its smaller constituent economies is enough to bring about a fundamental change is disturbing.  It wouldn't be able to ignore an election of Marine LePen as President of France - Gavyn Davies considers the consequences of that.

Update: Cecchetti and Schoenholtz also had a good post on the implications of a LePen win.


Gerald said...

"The fact that the eurozone rolls on with no sign that a depression in one of its smaller constituent economies is enough to bring about a fundamental change is disturbing."

Why so? Isn't it in fact encouraging, a sign that the eurozone can withstand such problems (especially a problem in one of its smaller economies)? There's scant reason to think it would be a good thing if the eurozone opted for "fundamental change" every time one of its constituent nations experienced a problem.

Bill C said...

Fair enough - it is true that the Greek crisis didn't cause the euro to break up at least. But I think what happened in Greece (and Ireland to an extent) is more than a local problem; it revealed a fundamental design flaw which they haven't fully confronted - the lack of a "banking union". From the outset, economists doubted whether the euro area met the traditional criteria for an optimum currency area (OCA), and those issues are relevant, but I think Greece shows that a banking union (i.e., shared lender of last resort, banking regulation and deposit insurance) is necessary to make it work. I.e., if Greek banks were european banks, the bank-sovereign "doom loop" could be circumvented. The euro area needs a way for countries to go bankrupt without bringing their banks down with them.

Gerald said...

I tend to agree with you regarding the necessity for a "banking union"; not having one is indeed a design flaw, and no, it hasn't been confronted. Does that mean the eurozone's days are numbered? Could be, but of course we won't know for certain-sure until the breakup does (or doesn't) happen. So it goes.