Break-up of EU currency union would lead to chaos

 

Austrian and Finnish ministers should be wary of making rash statements on the future of the euro, writes JOHN BRUTON

AUSTRIAN FOREIGN minister Michael Spindelegger is reported as having said recently that “we need the possibility to throw someone out of the monetary union”. And the Finnish foreign minister Erkki Tuomioja has been quoted as saying “the break-up of the euro does not mean the end of the EU. It could function better”.

Both men should read a paper by a man who actually has some direct recent experience of what happens after the breaking up of monetary unions.

He is Anders Aslund, and he worked as an adviser to the Russian government during the break-up of the rouble currency union between 1991 and 1994. The rouble had been the common currency of the former Soviet Union.

Aslund’s paper is published on the website of the Washington-based Peterson Institute of International Economics.

The first thing to say about what the two foreign ministers are advocating is that it is illegal. A country cannot be expelled from the euro under the existing treaties, and those treaties cannot be amended without the consent of all 27 EU states. This is no mere legalistic point. The EU has no police force to enforce the provisions of its treaties on those who have signed up to them. The entire existence of the EU rests on the voluntary acceptance of the rules laid down in the EU treaties by everybody. If this is called into question, as it would be if an attempt was made to remove a country from the euro, the whole basis of the EU itself ceases to have any meaning.

The framework of trust within which business is done would be shot through. One could no longer rely on EU rules being respected. The rule of the strong would be inaugurated, and business between countries would become impossible.

Aslund says the result of even one country leaving the currency union would be chaotic.

The first big problem would be what value to put in the uncleared, interbank balances that would be outstanding in the European Central Bank payments system at the moment of the departure of one or more countries from the euro. This automated system allows money transfers which are essential to keeping commerce flowing. These balances would probably be owed to states with trade surpluses, such as Germany, by countries running trade deficits, such as Greece.

If the valuation of these balances was disputed as between the euro and whatever new currency was issued overnight by (say) Greece, trade would freeze up because no one would trust one another’s payments.

Would the balances be settled in newly appreciated euro, or in the newly depreciated currency of countries departing the euro? If one country had departed from the euro, which country would be next? Everyone would send for their lawyers. The economy and trade could simply come to a stop because no one would trust the value of anybody else’s money. There would be huge losses of output and money, which would affect every country – creditors and debtors alike.

Because there would be so much uncertainty about the value of currencies, and doubt about the value of securities held by banks, there would be a risk of people no longer trusting their money in banks at all.

Since the abolition of the gold standard, all credit, and even money itself, is nowadays based simply on confidence and trust.

An attempt to break up a supposedly irreversible currency union, as envisaged by the Finnish and Austrian ministers, would undermine the confidence and trust upon which the entire European economy rests.

It would not be like a devaluation of an existing currency, but would instead be an attack on the entire framework underlying money in Europe. Aslund does not believe it would be possible for one country, such as Greece, to leave the euro without the whole system breaking up.

When the rouble-based monetary union of the old Soviet Union broke up, the newly independent central banks of the newly independent republics tried to give their own countries an advantage over others by loosening the purse strings and printing more of their new currencies.

This led to hyperinflation – rates of inflation of 100 per cent or more. There was a dramatic fall in living standards in all the former Soviet republics of about 52 per cent. People became 52 per cent worse off than they had been even under the decrepit Soviet system!

Some countries are still recovering from the chaos unleashed by the break-up of that monetary union. Creditor republics, such as Russia, lost just as much as did the republics that owed them the money.

That’s what actually happened the last time a multinational monetary and currency union broke up in Europe, just 20 years ago.

According to Aslund: “The causes of these large output falls were multiple: systemic change, competitive monetary emission leading to hyperinflation, the collapse of the payments system, defaults, exclusion from international finance, trade disruption and wars.” Similar events occurred in Yugoslavia when its currency union broke up, and also when the Austro-Hungarian Empire’s currency union broke up after the first World War. People would not want to accept new local currencies if they had the option of using dollars or another strong currency whose value would be more reliable. Money would flow into a few strong currencies and these currencies would appreciate artificially.

This would mean a loss of competitiveness for the countries concerned, and that might prompt them to reintroduce exchange and capital controls to prevent the loss of their export markets. That would destroy a pillar of the EU single market.

The single EU market would also be damaged if other EU countries used competitive devaluations to win market share.

The situation in the EU would probably be worse than in the Soviet case, because euro area economies are much more complex, and with automated and electronic trading, contagion can now spread even more quickly than it could in the 1990s.

Some argue Greece could gain from leaving the euro because it could devalue, thus making its exports more attractive. The devaluation would be like an overnight wage cut of 50 per cent. But there could just as easily be a total loss of confidence, a rush of money out of the country and hyperinflation. It is not clear anyway what export markets Greece could quickly exploit, with its new cheap currency, or how its neighbours would react.

The Austrian and Finnish foreign ministers should study a little more economic history before they make more such statements.

John Bruton is a former taoiseach and EU ambassador to the US

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