The sooner the better for the euro’s endgame

An email arrives from Terry Smith. Like me, he has long thought that a breakup of the euro would be a total disaster – something that would create such chaos and so many dominoing disasters that all efforts to avoid it (although doomed to failure in the end) have some value.

Like me, he is beginning to change his mind. The pain of keeping the zone together and forcing the peripherals to devalue internally when we all know that they will have to default and devalue in the end is just too much.

So, the sooner we reach the endgame for the euro, the better. Smith has forwarded a piece from Variant Perception on the subject. You can read the whole thing here – and you probably should.

The point it makes is that, over the last century, 69 countries have exited currency areas. Think the Austro-Hungarian Empire in 1919; Pakistan and Bangladesh in 1971; the USSR in 1992; Russia in 1998; Argentina in 2002. They’ve also mostly done so “with little downwards volatility”.

In almost all cases, real GDP declined for only two to four quarters. “Furthermore, real GDP levels rebounded to pre-crisis levels within two to three years and most countries were able to access international debt markets quickly.”

This all gives us something of a roadmap for dealing with our own crisis. How do we deal with the timing and announcement of exits, the introduction of new coins and notes, the denomination or re-denomination of private and public liabilities, and the division of central bank assets and liabilities? We look to history and see what worked for everyone else and what didn’t. 


“While every exit from a currency area is unique, exits share a few elements in common. Typically, before old notes and coins can be withdrawn, they are stamped in ink or a physical stamp is placed on them, and old unstamped notes are no longer legal tender.

“In the meantime, new notes are quickly printed. Capital controls are imposed at borders in order to prevent unstamped notes from leaving the country. Despite capital controls, old notes will inevitably escape the country and be deposited elsewhere as citizens pursue an economic advantage.

“Once new notes are available, old stamped notes are de-monetised and are no longer legal tender. This entire process has typically been accomplished in a few months,” says Jonathan Tepper, the author of the report. He then goes on to make 13 specific recommendations for a euro exit. This is clearly going to be a complicated business given just how many countries are involved. But it might not have to be quite as chaotic for quite as long as most people think. 

The real problem in Europe, as Tepper puts it, is that “EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging-market crises. The only way out of this is via orderly defaults and debt rescheduling coupled with devaluations”.

Defaults are only a partial solution in that they might leave the countries with less debt, but they’ll also leave them stuck with overvalued currencies that will keep building up imbalances. That makes default and devaluation both “inevitable and even desirable”.

The combination would of course cause sudden pain to creditors everywhere, but the hard truth is that their losses already exist. It is just a matter of whether they are crystallised now or later. The upshot? Getting out now – something Greece and Portugal should definitely do and Spain and Ireland should seriously consider – would mean that the pain of devaluation would be “brief, and rapid growth and recovery would follow”.

subscribe to MoneyWeek magazine will know that I have just been in Portugal and that there, the pain is being drawn out in a particularly nasty way. The same goes for Greece, where the human cost of internal devaluation via the labour market is mounting.

It is unlikely that the EU authorities will want to do anything drastic before the French elections. But once those are over, it is time to help Greece and Portugal cut themselves loose.