How Catastrophic Would a Break-Up of the Euro Zone Be?

If the euro were abandoned, then the previous regime of free-floating fiat currencies, each of them administered by its own central bank, would presumably be reestablished.

After all, unless the euro were to revert to its previous incarnations of national free floating fiat currencies the supply of which can be altered at will be the national central banks, there would be no point in leaving the euro area.

From the point of view of sovereign debtors that have difficulties financing themselves in the markets, the idea of being able to print their own money and have their national central banks back-stop the financing of the government is of course quite seductive and the primary motive that may induce some of them to consider leaving the euro. Moreover, the ability to pursue ‘beggar-thy-neighbor’ type trade policies by unilateral devaluing one’s currency is similarly tempting, as most modern-day governments continue to believe in the mercantilistic fallacy that trade is not mutually beneficial, but instead creates winners and losers. The popularity of this facile and entirely wrong notion will probably never go away. Naturally, not everybody can beggar his neighbor – if everybody did, then the desired effect  could not be achieved.

It is widely acknowledged that one of the main problems the euro has created consists of the inner-European current account imbalances and the large differences in the competitiveness among the various member states that have arisen.

However, if we think these assertions properly through, it should be obvious that there can be no simple aggregated arithmetic determination of these effects. Ricardo’s law of comparative cost remains operative after all – albeit, given the mobility of labor and capital in the euro area, only in a somewhat restricted manner.

We could for example  compare a range of products that can be produced by both Germany and Spain and come to conclusions about which mix of production activities would yield the greatest output for all these products. It seems inconceivable, even if one agrees that Spain has become relatively ‘uncompetitive’, that it would be better for Germany if it became autarkic and produced all the goods it could in theory produce by itself and that it would no longer make sense to produce any of them in Spain.

Moreover, there are certain things that Spain or Greece can produce that Germany can not produce at all and vice versa. Greece is not known for the achievements of its automobile industry, but neither is Germany famous for its olive groves.

We happen to believe that the fundamental nature of the problem the euro has fostered remains widely misunderstood. To say that Greece or Spain have become ‘uncompetitive’ relative to Germany and the Netherlands is not enough. One must rather ask: why has this happened? Once one grasps the why, it should be easier to determine a viable way forward.

Ignoring for the moment the question of whether the original exchange rates of  the national currencies to the euro that were applied upon its introduction were valuing these currencies ‘correctly’,  one can probably assume that the condition of the regions comprising the currency area on the eve of its introduction were such that this uncompetitiveness problem did not exist. It is clear however that with the passing of time, conditions always change. The market economy is in constant flux after all – the only thing that can be said to be permanent about it is change.

And yet, why should using a common medium of exchange per se be the primary agent of the changes that are now considered a negative outcome of its adoption?

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