The Eurozone – is there an escape hatch?

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By Cormac Lucey

Economic tensions are growing once more in the eurozone. That is evidenced by rising Target 2 balances which measure how much central banks in the eurozone’s northern countries are having to lend to their counterparts in southern countries to allow them keep their commercial banking systems functioning. It is also evidenced by the interest rate you can earn lending money to the German government. Last week it was -0.9%. What investors lose in the headline interest rate, they gain in reduced solvency risk and in reduced currency redenomination risk.

Nearly ten years into the Global Financial Crisis, there is little sign that the fundamental problems of the eurozone have been fixed. That is contributing to growing political risk as Dutch and French voters prepare to go to the polls. And it is causing some system insiders to consider the question of how to exit the eurozone.

A recent academic paper “How to abandon the common currency in exchange for a new national currency” was co-authored by Dr Peter Nyberg. The Finnish former top civil servant was tasked by the Irish government with formally reporting on how the Irish banking system collapsed. It is a telling commentary on officialdom’s lack of enthusiasm for the euro that he is now willing to publicly contemplate its disintegration.

The paper contends that “Historically, the existence of a political union has determined the success of monetary unions. When political unity has dissolved, the monetary union has been very likely to follow”. It also offers the classic argument in favour of national currencies: “The restoration of monetary policy enables rapid responses to adverse exogenous shocks. A flexible exchange rate provides an effective adjustment mechanism, which by far exceeds that of domestic prices.”

The paper identifies three key questions to determine the cost of currency zone exit. Firstly, can the exiting country guarantee the functioning of the payment system during the transition and can it re-establish an independent central bank? Secondly, is economic and political retaliation on the part of the remaining MU countries and/or authorities likely? And, thirdly, can banks (financial sector), companies and government entities in the exiting country remain liquid and solvent during the adjustment period? Let us hope that our authorities can answer these questions.