The Euro-Exit Taboo
Unlike the euro-zone members, Argentina never gave up its currency, the peso. Reintroducing a new currency quickly and simultaneously redenominating all obligations in the new currency would create an economic nightmare as creditors and depositors found their assets devalued. Myriad legal challenges would ensue. Defaulting on loans from other EU members carries enormous political costs and international treaty complications that Argentina did not have to bear. So would separating from the Eurosystem of Central Banks and liquidating the outstanding liabilities. Even though leaving the euro zone and defaulting would not necessarily mean abandoning the EU, it would nevertheless have profound foreign-policy (and, possibly, security) implications, as in the case of Greece’s ability to marshal allies in disputes with Turkey.
On the other hand, sticking it out like Latvia is likely to result in a more protracted and politically fraught adjustment for the euro zone. How so? To put it bluntly, Latvia had no choice but to adjust immediately as all its external financing dried up—between 2008 and 2009, its current account deficit swung from 13 percent of GDP to a surplus of 9.4 percent—a world-record 22.4 percent of GDP adjustment in one year. In comparison, the adjustment in the periphery of the euro zone has been minuscule. For example, four years into its crisis, Greece’s current account deficit remains near 10 percent of GDP. This is made possible by the automatic working of the Eurosystem of Central Banks, which provides for unlimited supply of euros to any central bank that needs them, as well as by large bailout packages, so that by design there can be no sudden stop of foreign financing comparable to that which hit Latvia.
Eventually, of course, financial markets will refuse to lend to a government or firm whose debts reach alarming levels (government debts in the European periphery are much higher than in Latvia), but that occurs much more gradually and selectively than if markets decide that a whole nation has become insolvent—and there is no lifeline from an official source or from a lender of last resort.
The choice to stay or leave the euro zone is made even starker by the fact that the monetary arrangement itself is being transformed in response to the crisis in ways that go to the heart of national sovereignty. The profound changes needed to make monetary union workable—greater fiscal integration, tighter fiscal rules, better coordination of countercyclical policies, monitoring of competitiveness and consultations on structural reforms, common banking regulations and resolution processes, and establishment of a lender of last resort—require joint decision making that, in democracies, implies much tighter political integration. Electorates will only accept the compromises and costs incurred by the euro zone if they are sure that the monetary arrangement itself is secure, forms part of a broader shared vision and that all its members, in the core and in the periphery, are shouldering the burden of reforms.
The End Game
Given the workings of the monetary union, the adjustment process in the periphery runs the risk of becoming so drawn out as to become politically unmanageable. In such a long and painful process, countries in the euro zone that might have been forced by markets to follow in Latvia’s radical adjustment path could one day find themselves, exhausted by permanent austerity, taking Argentina’s course of default and exit—though at much higher cost to them and their partners.
But the forces at play go beyond short-term politics and economics. In Latvia’s case, servicing debts and maintaining the peg were not seen as a mere choice of monetary arrangement but rather as a decision about what kind of country Latvia wanted to be: a part of Europe, or a small, distant province at the edge of the Baltic Sea, prey to the currents of history.
This imperfect comparison with Argentina and Latvia underscores the fact that leaving the euro zone would not, of itself, remedy the structural weaknesses of countries in the periphery. On the other hand, staying in requires the political will for quick changes, so the population is not exhausted by the process. That desire can only come from within the troubled countries, but it must be reinforced by an equally fierce determination at the core of Europe to make the monetary union work—essentially implying another huge step towards completion of the European project.
Uri Dadush is director of the International Economics Program at the Carnegie Endowment for International Peace and coauthor of Juggernaut: How Emerging Markets Are Reshaping Globalization.
Image: Lionel Allorge