September 12, 2006
Exit options for EMU
In today’s FT, John Kay comments on the question whether a single country (he chooses the example of Italy) can leave EMU . He argues that while it would be highly complicated to determine how single contracts would be changed from the euro to a new lira, after a long hassle, lawyers and bankers would find a solution if there was a political will.
Concerning the technical problems of leaving EMU, I would be even more optimistic than John Kay. After all, there is a precedent for leaving a fixed exchange rate regime with a high degree of foreign currency denomination of contracts, liabilities and assets: Argentina. The country pulled out of a currency board in the crisis of 2001/2002. Prior to this step, the government had spent years to explain to the people that “one peso is one dollar and one dollar is one peso”. People had taken this to their heart. There was a coexistence of payments in dollars and pesos as well as contracts denominated in both currencies. People sometimes paid in dollars and got their change mixed in small peso and dollar bills.
Argentina pesofied its economy rather swiftly
The change back to the peso went relatively easy: In the crises of 2001/2002, the government just passed a number of laws saying that all liabilities are to be converted in pesos. In addition, the country defaulted on its debt. While both measures took a long time to be finally settled in courts (and international arbitrage for foreign bond holders), economic activity started to gain traction very quickly again – with pesos as the main mean of exchange. And – without much work of lawyers and bankers – the laws were basically passed overnight.
Contrary to what most economists predicted at that time, the Argentine experiment did not end in chaos and hyperinflation. Supported with a number of price freezes, the inflationary impact of the devaluation remained limited.
When I travelled to Argentina in early 2003, one year after the crisis, the economy was up and working again. Dollarization had almost completely disappeared and the pre-devaluation recession had been replaced by a smooth recovery. By now, the country is its fifth year of strong growth. If you compare today’s GDP to the level of 2001, just before the crisis, in which output dipped by more than 10 percent, the Argentine economy is actually doing better than that of its neighbour Brazil. Unemployment is at its lowest level for almost ten years.
The interesting fact about the Argentine de-pesofication is that at the time, politicians did not seem to have much of a plan of what they were doing. Nevertheless, they managed to engineer a rather working exit of the currency board (even though I have to admit that economic policy could have done better since than, relying less on populist measures to rein inflation and maybe apply the traditional brakes of restrictive fiscal policy). This proposes that leaving a monetary union might technically much easier than many people think.
Cultural linkages between Italy and Argentina
What might make Argentina a possible role model from the perspective of populist Italian politicians is not only that it pulled out of a fixed exchange-rate-regime rather successfully, but also the cultural and ethnic linkages between the two countries. A lot of Italians immigrated to Argentina. Once you come to Argentina, you will not only taste the Italian influence in the Argentine cuisine (as it is much better than those of its neighbors and rich in pasta and pizza), but you will notice it also in the sound of the Spanish spoken. Many Argentines still have relatives in Italy, and prior to the crisis 2001, Italians small investors had heavily bought Argentine bonds. Italians follow more closely what happens in Argentina than most other Europeans.
I am not saying that pulling out of EMU would be a good option – neither for Italy nor for the rest of the euro-zone. Frankly, I believe it would be catastrophe for Europe. However, technically, it might be rather easy. We all who are in for a united Europe will have to address populist critics of EMU with better arguments.
Comments(8)
Hi Sebastian.
I have just put a post on this at Afoe, and have thrown you over a link.
Basically I think you, I and John Kay are all agreed that the marriage, technically speaking, can be disolved.
I also tend to agree with you about Argentina, but I think it can become a red herring here.
I think the main issue is the sustainability of Italy’s public debt dynamics in the context of its demographic outlook (as explained in my post) and not the rantings of populist politicians. If there were to be an exit, it would be explicitly in order to default IMHO.
“but you will notice it also in the sound of the Spanish spoken.”
I live in Spain Sebastian, and the differences between the Spanish and the Italian political systems are very apparent to me. I have often thought that Chile was more like Spain and Argentina more like Italy.
“Frankly, I believe it would be catastrophe for Europe.”
One problem here Sebastian is that this is assuming that there is a ‘good’ option. But what if there are only two ‘bad’ options. For a variety of reasons I am not convinced that the eurozone can survive in its present form, but let’s imagine that it is salvageable. Then the issue is, is it better to keep a workable core, and thus negotiate a ‘road map’ with Italy (and possibly Greece) for exit? Or is it better to wait till the thing blows up in our faces, and look to an uncertain outcome?
Look this whole John Kay article (like others in the FT) are a transparent attempt to disrupt the Euro project.
There is no push within Italy to leave the Euro and there is no real reason for doing so. Prodi is head of the Government. He supervised Italy’s entry into the Euro and the benefits have been notable: namely the huge fall in the level of nominal interest rates.
The motive behind these type of articles is to disrupt the move towards the use of the EURO as a GLOBAL RESERVE CURRENCY. Of course the USA, which IS running a MASSIVE EXTERNAL DEFICIT and needs to retain its status as a GLOBAL RESERVE, would be quite happy for this to happen.
It’s not going to happen and these kind of spurious articles are a waste of time.
The days of the USD as a global reserve are OVER. And the days of the STERLING as a global reserve ARE LONG GONE. Get over it guys.
Hi Sebastian,
Good post and as you can see it has caused some stir. On that note I have also posted a link over at Alpha.Sources with my comments.
As far as the technical difficulties goes I am not sure who to believe … you/Edward or Felix Salmon. But this stems more than anything else from the fact that it is theoretically/practically unclear for me what would happen. Safe to say though that it would be considered a failure for Europe and yet another dent in the big European project. I think this would be unfair but it is without a doubt true that EU as an institution would suffer if such a thing happened.
As I have expressed in a comment over at AFOE I am in fact torn in this question because I actually think the Euro is a very good idea and as such I am not affraid to admit that a unified Europe is something I would be in favor for. However, as an economist I just don’t see the Euro working on the current terms. It might work in the future and I will hail the day but some adjustments must be made !
Well, that’s interesting reading. The thing I find really problematic about disequilibria building in EMU, however, is that while in the case of Argentina the US’ interest in keeping the Peso-Greenback peg was practically zero. But is that the case for EMU and Italy or Spain? Well, probably no as Germany and France would be loth to see one of the EU founding members leaving.
I suppose that discussing options for EMU-exit cum default or sine default, really makes a lot less sense than putting resources into dicussing how a post crisis regime could or better should be like. Which is probably getting us to the design of either a fiscal transfer system and/or a stabilization fund. Apart from the more structural approach of removing migration barriers still build into the mostly not fully portable social security systems.
[...] My last post on exit options for EMU has caused quite some stir in the blogosphere. Not only the new blog on Roubini’s RGE Monitor, “Economonitor” by Felix Salmon, but also Edward Hugh on “a fistful of euros” and Claus Vistesen on “alpha.sources” as well as a good dozen on readers in the comment sections of these sites have reacted to my – obviously provocative – post. [...]
“Italians small investors had heavily bought Argentine bonds. Italians follow more closely what happens in Argentina than most other Europeans.”
No way:
“Olivieri: In Buenos Aires, we collaborated closely with Mr. Nielsen, who gave us all the documents which showed that Italian banks, including those which had no experience in the international bond market, had played an upfront role in the bond placement. After 1999, those banks even became the leaders in the bond placement. This means, that they would purchase bonds from the Argentine government, to sell them on the secondary market, gaining a 0.4% commission. We made an approximate calculation, and concluded that Italian banks gained about 2.5 billion euros from the sale of Argentine bonds.
However, almost the totality of those bonds were bound to the condition that they should be sold to institutional investors, and not to the retail market. Despite that, the banks sold them to their customers. And in 2001, they were telling their customers to buy Argentine bonds, at the same time that they were getting rid of those same bonds, expecting a default. That is the anomaly, and now we have been able to document that. That is why we speak of betrayed savings, “risparmio tradito.”
http://www.larouchepub.com/other/interviews/2005/3210luigi_olivieri.html
[...] One of the hottest topics in the debate on Eurozone economics over the past months has been the question whether dangerous divergences are building between the 12 countries which share the euro. In fact, the fear that some countries might have lost competitiveness to a dangerous degree has been behind scenarios of countries leaving EMU (there has been a lively debate in the blogosphere and on Eurozone Watch – see here and here and here). [...]
[...] Eichengreen sees large technical problems (even larger than what has been argued on Eurozone Watch), but more limited political problems with a country leaving EMU. According to him, the reintroduction of the national currency would need adequate time to prepare, a time in which one could expect large capital flights. On the other hand, he believes that politically, a country leaving EMU would be reduced to "second-class status" in negotiations over other EU issues. Different from some other commentators, however, he believes that the country leaving EMU could do so without leaving the EU completely. [...]