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Abolish the euro, stop losses!

2011/10/23

Next week, once again there will be endless debates about success or failure of the latest “solution” European leaders agree on in order to overcome the eurozone crisis. Will the additional levers given to the EFSF suffice to calm down markets and prevent contagion? Will the recapitalization of banks strengthen their ability to digest further losses? Will the increase of private sector involvement in the “rescue” of Greece suffice to save the country from bankruptcy and, at the same time, quieten the critics in national parliaments and elsewhere?

The current agreement again, above all, will serve to buy time. Nobody is really expecting it to end the European drama. There is widespread agreement that this could be achieved only by far-reaching further integration including the creation of eurobonds  and the transition to a full-fledged fiscal union.

However, as I argued elsewhere, even eurobonds would be no panacea. As long as financial markets find a way to discriminate between countries  – and the poor integration of most financial market segments in Europe offer ample opportunities in this respect  – and as long as derivative constructs provide for unlimited liquidity, the differences between national economies will be incentive enough to test the system again and again (and neither Charles Goodhart’s  2% minimalist federal fiscal union nor the recent proposal of the Bruegel Institute would hinder them). One lesson from the EMS crisis of the 1990s is that, in the long run, if markets do not believe in a system it has no chance to survive.

In the eurozone, big economic differences will continue to exist and cannot be expected to be eliminated in the foreseeable future. On the other hand, the prospects for deeper integration in the sense, for example, of a one and only eurobond market are nil. Under these circumstances, the only way out of the crisis is to admit the failure of the euro experiment and to abandon the project as fast as possible. Every new round of rescue action and austerity program, shift in market sentiment and renewed policy initiative will only lead to more friction and increase the cost to maintain a system which is doomed to die. No ban of financial strategies or rating activities, and no increase of public funds for intervention, can change that. Had the decision to abolish the common currency been made months ago at the first indications of the system’s inconsistencies the cost  for all members as well as other trading and financial partners in the world would have been considerably lower.

People currently debate the pros and cons of the various components of the latest policy agreement as if they were an alternative to quitting the euro. They are wrong. There is no way to stem the floods of financial speculation except policy credibility, and the euro has long lost this opportunity.

In financial markets there is one rule which is crucial for survival and which applies to this case, too: Stop losses. If a position or activity is losing you money again and again, and you have no indication for change, quit it. If you expect the situation to improve, consider the risk. But if your expectation is grounded on hope instead of information, quit. Is expectation in the eurozone these days grounded on information or on hope? Is it a calculable risk policy is taking deliberately or is it uncertainty and high non-quantifiable ambiguity? In the first case, every effort may be justified to save the system, in the second there is a danger to lose much more than a common currency.

Stop losses. It is high time for European leaders to follow this rule.

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3 Comments
  1. Whilst I agree with the majority of your article there are certain aspects that I feel need more clarity.
    1, There is still no mechanism for any member state to leave or be expelled from the eurozone. This was a flaw in the system from the outset that remains to be resolved.
    2, There is no mechanism for the total abolition of the euro and a return to multiple currencies. Again, a flaw that remains to be resolved.
    3, There is not the political will or courage among the eurozone leadership to admit the error of the single currency, which negates the possibility of them seeking the means to facilitate the orderly break up of the euro.
    On the basis of these three points the eurozone leadership will continue to fudge the issue and attempt to buy time until they can achieve full fiscal union. The belief being that this will enable the eurozone to stabilize itself and begin a recovery process. The danger here is two-fold, 1) the amount of time required to achieve such a goal is too great, 2) the destabilization would increase to include the safer members of the euro such as France and Germany. This is already beginning to happen.
    The greatest danger in all of this is that we get a disorderly break-up of the euro led by the financial markets and then spreading to the populations of member countries with civil unrest and anarchy the result. This has then the potential to lead to war between member countries, an outcome Angela Merkel alluded to in a previous comment.
    Please feel free to agree/disagree and comment on my view..

    • Thank you for your comment with which I largely agree, except perhaps the last point. One explanation why there are no rules for abolishing the euro, or one country leaving the system, may be that the founders made every effort to build trust in the new system and the new currency and certainly did not want to raise the point of failure. As a result, as you write, Europe now faces the possibility of disorderly breakup and time may be too short to adopt longer-term stabilization measures.

      Concerning the effects of a breakup, I have three objections to your line of reasoning.
      1. Disorderly does not necessarily mean more costly than the status quo. Kicking the can, and the related market reactions, so far has already taken a heavy toll. One example: A quick and decided abandonment of the euro several months ago would have limited the rise of borrowing cost and left most member countries unharmed. No contagion in other parts of the worlds, no campaigns to collect money in Beijing and Washington. But as you write: Leaders were and are not willing to admit the error.
      2. Even if the time would suffice for longer-term adjustments, in my view, these were probably to no avail. As I wrote elsewhere, in my view, the current crisis is not a problem of individual countries and not rooted in macroeconomic developments but a system failure which cannot be cured without widely unacceptable political commitment.
      3. Like many observers you seem to equate disorderly with chaos, panic, bank runs, bankruptcies, political instability and so on. I am not certain how much of all this will actually occur. I would rather think not much. The euro breakup is no “black swan”. One advantage of all this can kicking and bickering is that the end will hardly come as a surprise. This means that many actors have made provisions and there is a not so small chance that adjustments will be much smoother than doomsayers would have us believe.

  2. carlos9900 permalink

    Dear Beate, you have never convinced me that we should eliminate our Euro. I’ll keep folling you and reading you.

    Dear Jesus, any member can withdrawal from the EU, thus, leaving the Euro. http://en.wikipedia.org/wiki/Withdrawal_from_the_European_Union

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