Start planning for Eurozone break-up

Allister Heath
ONE should always have a Plan B, an emergency exit strategy. Offices, cinemas and restaurants always have a way out in the event of a fire; nobody would want to travel on a boat without life rafts in working order. It is bizarre, therefore, that such common sense has until now been absent from economic and financial planning.

Financial institutions grew into giant behemoths without anybody working out what would happen if things went wrong – there were no living wills, no special resolution procedures to unwind bust banks without taking down entire economies, no real plan of action to deal with catastrophe. The assumption appeared to be either that Armageddon would never happen or that the government would always be able to step in and sort everything out easily if it did.

It was the same with the single currency. Countries that took part purchased a one-way ticket on the Titanic. There was no way of exiting, no mechanism to allow states that ultimately couldn’t cope to pull out. Problems were defined away: in theory, bailouts were illegal and all member states were contracted to pursue sustainable policies. In the case of the Eurozone, this was deliberate: political projects of that magnitude need to feel inevitable if they are ever to have a chance of getting off the ground.

Lots of work has taken place on trying to devise special bankruptcy procedures for banks, especially in America. Yet progress has been slow and none of this is ready for Ireland’s fallen giants. But it is not too late for a new plan to allow weaker countries to exit the euro at a minimum economic cost to the rest of us. George Osborne was right to warn Eurosceptics that “I told you so isn’t much of an economic policy” but that doesn’t mean that endless bailouts are the answer either.

Imagine what would happen were the contagion to reach Italy or Spain. The European Central Bank would step in, purchasing hundreds of billion of euros worth of bonds from those countries, paid for by freshly created money. This would outrage the Germans, who only put up with the euro because they think the European Central Bank shares the Bundesbank’s hawkishness. German citizens would rightly hate to see the value of the euro in their pocket being put at risk by the ECB monetising the debt of profligate Club Med countries. They would be even more angered by the next step, an Irish or Greek-style bailout. The disenchantment would work both ways. There have been dozens of IMF bailouts over the years, mainly of countries in Africa and Latin America; rarely do the recipients thank their “rescuers”. Bailouts always come with strings attached and invariably fuel rage, protectionism and nationalism. It would be no different in the EU.

So it is looking grim for the single currency. One option would be for troubled countries to be booted out. Unfortunately, replacement currencies would lack credibility and slump instantly, making it impossible for countries to repay any euro-denominated debt. They would have to peg their new currencies to a commodity, such as gold, but that would require a credible economic policy. Another option would be for the Eurozone to break into two, with the core – led by Germany – adopting a strong currency and the periphery a weaker one. Again, this would be fraught with problems. One thing is certain, however: now is the time to begin working on a plan B for the Eurozone.