No easy exit from the euro

Megan McArdle

Keith Humphreys ruminates on the folly of the euro, and why the governments involved can’t even seem to bring themselves to consider the possibility that the euro should be abandoned. Paul Krugman has remarked that, “The euro was best understood as a plot by Italian technocrats to get themselves German central bankers.”

As he adds, “This was not, it turns out, a good idea.”

Humphreys, who is a psychologist, not an economist, wonders if the eurocrats are committing a fundamental cognitive error: The euro area “falsely assumes that rearranging the consequences of and responsibilities for financial decisions would not affect subsequent financial decisions by participants [be they individuals, businesses, elected officials or bankers].”

As a longtime euroskeptic, who has frequently flirted with the idea that the euro must eventually destroy itself, I am sympathetic to Humphreys’ point. But let me attempt to offer a partial defense of the hapless eurocrats: However stupid the creation of the euro was, undoing it will not be easy.

Yes, we’re back to our old friend path dependence. As I noted the other day, the fact that you can avoid some sort of terrible fate by stopping something before it starts does not mean that you can later achieve the same salutary effects by ceasing whatever stupid thing you have done. It would have been painless just to not have the euro. But it will be painful indeed to get rid of it.

Just imagining the transition is daunting. Any of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) that announces plans to move off the euro will trigger a run on its banking system, as people try to relocate their euros to Germany. So you have to do a bank account freeze, which creates all sorts of other problems. Moving off the euro would also constitute a default on euro-denominated bonds, unless you agree to repay the bonds in euros, which is a recipe for a debt crisis like Argentina’s. It’s hard to see how anyone gets out of the euro without at least a deep local crisis, and quite possibly another round of global crises, as the chain reaction melts down markets around the world.

No wonder no one wants even to discuss it. Especially since even discussing a dissolution of the euro area makes a crisis more likely; if investors decide that Italy is likely to leave, they will start fleeing Italian debt almost as fast as they would if Italy had already left.

That doesn’t mean that it won’t eventually happen; I still think this remains a real risk. But if it does, public officials will probably be denying the possibility right up to the bitter, unpleasant end.

BY Megan McArdle, Bloomberg View columnist on economics, business and public policy