A long time ago, in a monetary union far, far away…
The alliance had been a dream for many years, and when the euro was introduced on January 1, 1999, bells rang out and people danced in the streets, speaking many languages, but promising to spend, save, and invest in one common currency. Eleven sovereign states had met the convergence criteria and adopted the euro that day, agreeing to fiscal and monetary constraints intended to keep the union strong. Soon, six more nations would follow suit and adopt the new currency, expanding the Eurozone and economic benefits contained therein. But then, a crisis arose. No one expected a global credit meltdown, so widespread and sinister, that it would strain the economic ties and commitments that bound the union together. The balance between unity and sovereignty would be tested like never before…
Since we committed to talk about something hypothetical, we might as well make it interesting! The breakup of the European monetary union is pure fiction at present, not much different than next week’s 3D re-release of the 1999 blockbuster Star Wars prequel. Chatham is not predicting, encouraging, supporting, desiring, or condoning a full or partial Eurozone dissolution. That said, we have seen many seemingly improbable events occur over the last several years, including a Lehman Brothers bankruptcy, a U. S. credit rating downgrade, and a near-zero interest rate policy (ZIRP) three years running, with perhaps two more years head of steam. In this day and age you must be willing to suspend disbelief, at least long enough to critically examine the implications of events generally thought to be incapable of happening. Because they just might happen.
The Eurozone Situation. If you follow the markets even casually, then you have a rough sense of the state of affairs in Europe, and the wide disparity in fiscal and economic conditions among its member nations. It’s truly A Tale of Two Europes , with countries like Germany navigating the credit crisis in relatively strong shape, and countries like Greece, Portugal, Spain, Italy, and Ireland struggling with near unmanageable debt loads or poor growth prospects. In March 2012, this union will be tested with a very real threat of sovereign default, as nearly 17.5bn euros in government bonds come due for Greece, which presently does not have the money to repay these obligations. A default in and of itself does not break the Eurozone apart. But an unwillingness of the Greek people to accept more austerity measures, and an unwillingness of the German people and citizens of other countries to lend one euro cent more to Greece if they don’t, could sow the seeds of dissolution.
A Full or Partial Dissolution. To say that the Eurozone could break up is not to say that all 17 member states would go their separate ways with new currencies, although that is one scenario. While a full breakup is possible, partial dissolution scenarios abound. For example, one member could leave, adopting a new currency (likely its former currency), or several could leave at one time, and create at least one new currency union (and possibly more). Partial dissolution scenarios in turn would leave behind the euro (now a “euro-lite” currency) still in force in remaining nations. While a number of permutations exist, the one thing they all have in common is that there is no mechanism in place today to actually depart the euro. The threat of a unilateral withdrawal was pure conjecture until events in Greece this past Fall brought it into focus.
A Disorderly Departure. In November 2011, the former Greek Prime Minister George Papandreou scrapped a startling referendum to put Greece’s euro membership to a vote by the Greek people. Had he gone through with the referendum, with the country already straining under burdensome austerity measures, Greece may have voted themselves out of the euro! This would have been the start of a disorderly departure (since there is no mechanism), and there is no reason to think that Greece or another nation wouldn’t actually put their euro membership to a vote at some future date. As sovereign nations, internal political pressures may pit the needs of the nation against those of the union. Without stronger political ties between countries in the Eurozone, and to a central authority (think, “United States of Europe”) this will always be a possibility, even if remote.
Adopting a Mechanism. If world markets and Eurozone leaders eventually see that a member nation’s departure is imminent, it could be in everyone’s best interests to make this process as orderly as possible. That would require drafting rules, and creating a mechanism for a nation to withdraw. There has been much talk of a mechanism to save the euro, the “European Stability Mechanism,” which is intended to succeed the “European Financial Stability Facility” (i.e., the “Eurozone Bailout Fund”). While it is difficult to imagine European leaders promoting a “European Departure Mechanism” in tandem, it is clear that ignoring this when faced with an imminent member departure could create instability instead, not only for the departing member and remaining nations, but for world markets and systemically important institutions as well.
Tune in next week for Part 2 in this series, Redenomination Risk (“Episode II: Return of the Drachma”).