Dissolving the Eurozone

15. 3. 2017

It is now clear that the various measures that have been undertaken since 2010 have been ineffective and they have failed to stop the spread of the crisis. We have less than a year to abandon the euro and reintroduce national currencies.

The situation in the eurozone is deteriorating with every new day. One should not expect economic growth in the near future in Northern Europe. At the same time Southern Europe has clearly entered into a period of recession (for example Spain, France and Italy) or is already deep in recession (as Portugal, and of course Greece).

There is a risk that the situation in most of the countries will become even worse as a result of a set of ill-designed policies, which address only one aspect of the crisis (public finance) and in the end, the eurozone will crash, country by country.

The Competitiveness Crisis

The solutions that have been applied so far have proved to be unsatisfactory. The agents and the institutions that have sufficient liquid assets are massively turning down the bonds issued by Spain and Italy, even in the short term. Taking into consideration the needs of Spain and Italy, it is probable that the capacity of European Stability Mechanism (ESM) and European Financial Stability Facility (EFSF) to act will become neutralized by the end of 2012. There is an urgent need to find additional resources for Greece, Portugal, and Ireland which are not capable of keeping their commitments in regard to the deadlines of adjusting their budgets.

The financial crisis, which we have observed in the short term perspective, is actually a direct result of an internal and external competitiveness crisis. The disparities between the cost of labour in different countries has been constantly rising for the last years. A 20% reduction of labour costs should be instantly applied in France, and this number should be higher in Spain and Italy, not to mention Greece and Portugal. Otherwise, the countries concerned will surely witness an increase in their trade deficits and a process of a precipitated deindustrialization.

The real cause for the competitiveness gap, which has affected so many countries and cut down employment in the industry, even in France, is the rate of inflation, and in particular salary inflation. In every country, part of inflation corresponds to its economy structure—this is called structural inflation. All efforts to lower the above mentioned type of inflation result in a decrease of the growth rate, which economists describe as the output gap. It can therefore be assumed, that differing inflation rates will persist, unless those countries whose economic structures are more “inflationary”, agree to sacrifice their growth (and ultimately employment) in order to keep the level of inflation as low as those countries, whose structures enable them to attain those rates more easily.

Nevertheless, Germany stands out because of its lower structural inflation rate, not gains in productivity. The disparity is significant as it amounts to 25% for France and Spain, over 35% for Portugal and over 40% for Greece. The single currency was adopted so that countries could protect themselves from the so called beggar-thyneighbour policies of other countries. Instead of limiting such practices, the single currency had given them a new dimension and at the same time has changed the way they are applied. For example, Italy has weaker inflation than France as well. This inflation rate is much lower than the rate of structural inflation, and thus Italy has suffered from particularly low growth (1% a year on average since 2003). In addition, Italy’s productivity gains have been among the weakest in Europe.

Alternative Solutions

It can be concluded that labour costs should be lowered by approximately 20%. Such a reduction of labour costs could theoretically be done in three ways.

Within the eurozone, this could be achieved by a disproportional increase in salaries, and consequently of inflation, as in the case of Germany. Yet, these parameters cannot be easily modified, and in order to increase the necessary gap, Germany would have to agree to an annual inflation level of 12% for a period of two years. This is totally delusive of course.

The second option is to adopt an aggressive policy of a nominal salary deflation, the consequences of which would be disastrous, as this would mean a fall of consumption between 12% to 15% (due to the multiplier effect), and result in a decrease of the GDP between 4–5% a year. Unemployment would soar, affecting 20% of the active population in the case of France, 29% in Spain, 35% in Portugal and 52% in Greece. In these circumstances, it would be impossible to implement a financial recovery policy with the involvement of the government, as the decrease in GDP would trigger a more than proportional reduction in the tax revenues.

Let us note that a salary deflation policy would also have a profound impact on new EU member states. A massive slowdown of activity would thus mean a decrease of exports from these countries which are sub-contractors for Germany, France and Italy. A decrease in exports could, in turn, be disastrous for these still highly vulnerable economies.

There is yet a third solution which is considered by more and more economists: devaluation. In order for this solution to be put into place, the countries of the eurozone would have to acknowledge the vast disparities between the economic structures that have grown in the last 10 years, agree to suspend the euro and return to national currencies. Devaluation is in fact the simplest, fastest and the least painful way to lower the cost of labour in France. Such devaluation would have to correspond to the problems that different countries face. It is estimated that the rate for Greece would amount to 50%, 40% for Portugal, 35% for Spain, 25% for Italy and 20% for France.

This choice would be the simplest and least costly answer to the problem of competitiveness faced by many countries. Nevertheless, it must be stressed that such a solution needs to be implemented quickly. Should we continue to strive to keep the euro alive, countries in the zone will be exposed to a gradual loss of credibility and success of the whole operation will be compromised. Thus, the only possible solution would be to gradually disintegrate the whole zone. Let us add, that striving for the survival of the euro would demand fiscal adjustment policies, austere budgets and push the eurozone into a deep depression even more. This would also increase the immediate costs related to leaving the eurozone, due to a growing wave of international speculation, which is approaching anyway.

The “Save Yourself” Approach

There is still a window of opportunity today, which will remain open for about one year or less. It is now that the conditions of carrying out a dissolution are the most favourable. However, if no decision is taken in this period, we will be hit by the accumulated recession, a liquidity crisis and the consequences of the competitiveness crisis. The only solution available then will be to act on the basis of “save yourself” which would have disastrous consequences.

It must be clear that not only the members of the eurozone would be affected, but the new EU member states also. The latter would not only suffer the consequences of the continued efforts to save the euro, but also pay a heavy price for the return to the nationalist politics in the eurozone states. Aside from the consequences that have already been mentioned, we would also witness a sudden refocus of financial activity to the detriment of these countries. Banking systems would not be immune to all these processes. Finally, the rising tide of nationalism in the countries of the ex-eurozone would likely bring back custom tariffs. This would mean penalizing countries such as Poland, Slovenia, the Czech Republic, Slovakia or Hungary to an even larger extent.

The best available solution is to reach consensus on dissolving the eurozone or suspending the single currency mechanism. In this way, we could address the fears and uncertainties concerning the future of the European Union, the possible collapse of the eurozone and return of nationalistic self-interest. The decision to dissolve the eurozone could be presented as a common European decision and not as a return to nationalist politics. The achievements of European integration would be partly preserved.

This conviction is already very strong in such countries as Germany or France, where surveys show that the majority of the population are unfavourable towards the euro (52% in Germany) and would not vote for the Maastricht treaty which is the cornerstone of the single currency (65% of the French). Reluctance towards the euro is visible also in Eastern Europe, in countries like Bulgaria, the Czech Republic and Hungary.

A concerted dissolution of the eurozone is a way to avoid its collapse, which is highly probable unless we act in time. Such an outcome is to be expected if nothing is done and the crisis deepens even more. Countries would be pushed to make an independent decision to leave the zone: Greece, Portugal, Italy and finally France. A lack of coordination in making those decisions would bring even more chaos to Europe. In addition for some countries, leaving the eurozone would entail a unilateral debt default and the application of restrictive measures which would affect the free movement of people and goods.

A decision taken in a coordinated manner would provide the means to determine the level of a reasonable devaluation and re-evaluation, as well as to come up with mechanisms regulating the new terms.

However, it is essential that the euro is fully dissolved so that the debts, which until now have been in euros, are re-denominated to the currency of the issuing country in accordance with the international rule of law. It is a critical point for most countries and applies to sovereign debt as well as corporate debt, as states the international rule of law.

Therefore, the dissolution of euro seems to be a reasonable solution to the problem of the current crisis. By reintroducing a flexible currency exchange rate system, the countries that have experienced the biggest difficulties would gain the flexibility to introduce reasonable solutions to the problem of public finance and re-establish their competitiveness.

Jacques Sapir

Jacques Sapir is a French economist and economic commentator, Head of École des Hautes Études et Sciences Sociales and the Centre d’Étude des Modes d’Industriali-sation in Paris, Visiting Professor at Moscow School of Economics (Moskov-skaya Shkola Ekonomiki). He has recently published Faut-il sortir de l’euro? (2012) and Les scenarii de dissolution de l’euro (2013) – together with Philippe Murer.

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