Thursday, December 8

Der Euro

Rusty joins me in the office oblivious to the crisis surrounding him.

So, to the Euro, which I am asked about often these days. In future, I will direct my friends here.  Sooo.. A break-up, even a partial one, would be chaotic. A full or comprehensive break-up, with the eurozone becoming a Greater Deutschmark with maybe ten other currencies, would create pandemonium. It would not be a planned, orderly, gradual unwinding of existing political, economic and legal commitments. Exit, partial or full, would probably be precipitated by disorderly sovereign defaults in the fiscally and competitively weak member states, whose currencies collapse and banks fail.  If Spain and Italy were to exit, there would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression.

Consider ditching Greece, which amounts to just 2% of the eurozone economy : Most contracts, including bank deposits, sovereign debt, pensions and wages would be denominated in new Drachma and a sharp devaluation of, say 65%, of the new currency would follow.  As soon as an exit anticipated, depositors would flee Greek banks and all new lending governed by Greek law would in effect cease. Even before the exit, the sovereign and the banking system would fail b/c of a lack of funding.  Following the exit, contracts and finl instruments written under foreign law would probably remain euro-dominated. Balance sheets would become unbalanced and widespread default, insolvency and bankruptcy would result. Greek output would collapse.

Greece would temporarily gain a competitive advantage from the sharp decline in the new Drachma's value but, like Portugal, Spain and Italy, Greece does not have the persistent nominal rigidities to make it a lasting competitive advantage. Sovereign wage and price inflation would restore the uncompetitive status quo. Without external funding, imports would collapse, disrupting domestic production. Aggregate demand and aggregate supply would chase each other downwards.

If Greece kicked out because other member states (Germany) refuse to fund the Greek sovereign and the European Central Bank refuses to fund Greek banks, the markets would beam on the next most likely country to go.This would prompt a run on that country's banks and stop funding for its sovereign, financial institutions and companies.  Fear might then force the departure of the afflicted country. Exit contagion might sweep right through the rest of the eurozone periphery - Portugal, Ireland, Spain and Italy -and then Belgium, Austria and France.

Boom.