The Consequences of a Eurozone Breakup

It might have been better not to create the euro in the first place, but now that it exists its "unwinding" is neither desirable nor inevitable. There is no unwinding of this system without causing a much worse mess than the one we already have. If you think things are hard right now, see what happens if the eurozone comes apart.

Willem Buiter thinks through some of the possibilities in the FT: The terrible consequences of a eurozone collapse. His thinking on a voluntary exit by Germany, as opposed to coerced exits by the fiscally stressed (a more popular scenario), is especially interesting. That would be no better, he argues.

Exits by Germany and other fiscally and competitively strong countries could be even more disruptive. This might occur amid attempts to introduce a one-sided fiscal union with open-ended and uncapped euro-bonds or other transfers from the strong to the weak without a corresponding surrender of fiscal sovereignty to prevent future crises or if the ECB were to "go Weimar". I consider this highly unlikely, with a probability of less than 3 per cent. Following such an exit, Germany and the other core eurozone member states (perhaps excluding France) would introduce a new Deutschmark. The sovereigns in the periphery would default. The new Deutschmark would appreciate sharply. Financial institutions in the new area would have to be bailed out because of losses from exposure to the old periphery and the soft core. As nothing would be holding the remaining eurozone countries together, the rump would split into perhaps 11 national currencies. The legal meaning and validity of all euro-denominated contracts and instruments would be up for grabs. Everyone, except lawyers specialising in the Lex Monetae, would become much poorer.

Even if a break-up of the eurozone does not destroy the EU completely and precipitate the kind of conflicts that disfigured the continent in the past, the case for keeping the show on the road seems rather robust.