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Is there any scenario for a break-up of the Euro zone?
Let's say a Eurozone country faces a bank failure and the debt of the failing bank is very large relative to that country's gdp. This could happen in many countries. The fiscal authority of that country cannot do the bailout on its own, in part because the resources are not there and in part because the country lacks the political unity for raising taxes. The other EU countries cannot be persuaded to ante up. The country in question either loses its major bank, and suffers the concomitant fall out, or it creates "on the spot" monetary policy to save the bank. That means creating a domestic currency and suddenly announcing that the accounts of the bank will be reimbursed in terms of that currency rather than Euros.
I believe the odds of this outcome are relatively small.
That said, the "easy" option is for the ECB to do the bailout in terms of Euros. A non-unanimity-requiring procedure for this should be worked out in advance to a greater degree than is currently the case. And such a procedure may need to be worked out soon, while it is still unclear who would be the winners and losers from such an arrangement.
Posted by Tyler Cowen on October 11, 2008 at 03:18 PM in Economics | Permalink
Comments
Haven't you guys been predicting the fall of the Eurozone eventually? Why not this way?
Posted by: Apep at Oct 11, 2008 3:35:59 PM
Question:
Why would it be important for a small country to bail out their gigantic home bank?
Stay with me here.
If the bank is so gigantic relative to it's home country, then most likely a large portion of that bank's business is done outside of it's home country. Perhaps many of it's depositors are foreign, it's bondholders may be foreign, and so on.
So a huge bank failure needn't be as calamitous for these little countries as they are for larger countries.
Just a little theory.
Posted by: Mercutio.Mont at Oct 11, 2008 3:36:12 PM
Just let the bank fail. The cost would be less then dropping out of the EU. Paying creditors back in a new currency would be seen as defaulting anyway.
Posted by: mm at Oct 11, 2008 3:50:43 PM
This could have been the case in Ireland. However, the nature of the crisis is slightly different here (based on loans to the construction sector which may go either way), and there is now a growing acceptance that taxes will have to rise to counter our worsening fiscal stance.
Posted by: Millian at Oct 11, 2008 4:11:00 PM
Remember Reverse Auctions:
http://www.nytimes.com/2008/10/12/business/12imf.html?hp
"And the federal government meanwhile has directed Fannie Mae and Freddie Mac, the government-controlled mortgage giants, to ramp up their purchases of troubled mortgage bonds, in what could be a speedier and less formal process than the reverse auctions proposed by the Treasury...
“I am not aware that the Treasury Department presented any evidence on auctions that have been successful when they are used for assets that are so heterogeneous,” said William Poole, who retired in August as president of the Federal Reserve Bank of St. Louis.
Because Fannie Mae and Freddie Mac, the mortgage giants, buy and sell mortgage securities every day, they could avoid the arduous process of establishing a price for the assets through auctions."
I guess I was correct. They were a problem.
Posted by: Don the libertarian Democrat at Oct 11, 2008 4:39:10 PM
Nobody will be allowed to leave the ship.
It seems we will come out of this crisis with Lenin's Socialist United States of Europe
Posted by: Vit at Oct 11, 2008 6:33:35 PM
"I believe the odds of ...": can one get "odds of"? Aren't they "odds on" or "odds against"?
Posted by: dearieme at Oct 11, 2008 7:33:20 PM
Isn't it obvious that "odds of x"="odds of x happening"? And people in financial circles are talking about this as being a serious possibility...
Posted by: anon at Oct 11, 2008 10:24:27 PM
While the break-up of the Eurozone can't be ruled out --- especially if the real economy in a major country like France sinks into a big recession compared, say, to Germany's economy --- it seems fanciful right now. As for the banking systems in Europe, not just the eurozone or the EU (Switzerland), the ratio of short-term liabilities as a percentage of 1) national debt and of 2) GDP, and 3) average bank leverage ratio (bank assets divided by net worth)are just staggering . . . especially compared to the USA's problems on these three scores.
An article, with a good diagram of all this, appeared in the NY Times yesterday (Oct 12, 2008) Click here
In case the link doesn't work, here are some examples taken from the diagram:
Belgium 1) short-term bank liabilities % of nat. debt: 367%; 2) % of GDP, 285%; 3) leverage 33:1
Switzerland 1) 1,273%; 2) 280%; 3) 29:1
Britain 1) 368; 2) 256%; 3) 24:1
France 1) 128% 2) 60%; 3) 28:1
Germany 1) 167%; 2) 60%; 3) 52:1
USA 1) 43% 3) 15% 3) 12:1
.........
Quite a contrast, no?
Michael Gordon, AKA, the buggy professor
Posted by: the buggy professor at Oct 12, 2008 11:47:11 AM
Parts of this crisis reminds me Argentina 2001. With no bailout from IMF or anyone else, credit dried out and there was literally no cash in the market. Accounts were frozen for years. New pseudo currency was printed by the provinces themselves to pay salaries, with no real backing colateral, so such currency was accepted at a discount or not accepted at all.
Imagine a McDonald's menu with 5 or 10 prices for the same hamburguer, in different "state currencies".
A good account of the events leading to the meltdown are in Argentina's former economy minister Domingo Cavallo's Blog. SOme articles are in English. www.cavallo.com.ar
Enjoy
Posted by: at Oct 12, 2008 4:52:47 PM
Just returned from a wonderfully long vacation in Southern France (Languedoc), where my wife's father and his side of the family grew up and live.
Fluent in several languages (mother Scottish, father French), well schooled in European and world history, and a world-travelling businessman in the aluminum industry, he always has interesting observations.
He thinks that the crisis will force "core" Eurozone countries -- France, Germany, Belgium, Finland, etc. -- to work ever more closely in concert on economic policy, increasing the likelihood that these "core" countries will become a single nation-state within a decade. The logic being that such close coordination of economic policy would further erode inter-European nation-state policy boundaries.
Posted by: Jeff Garzik at Oct 12, 2008 9:52:20 PM
