Why breaking up is so hard to do

by Martin Wolf

Financial Times
September 20, 2011

Members of the eurozone are suffering from a severe bout of buyers’ remorse. Many would like to disassemble the kit they bought almost 20 years ago and put together in the late 1990s and 2000s. But they can only break it, together with the entire structure of European co-operation. Meanwhile, the world looks on in horror at the possibility that the eurozone is about to unleash a wave of sovereign debt and banking crises. If so, it would not be the first time that European folly has brought ruin on the world.

The idealism that drove the project has vanished. But self-interest is proving an insufficient replacement. The fumblings of national politicians, answerable to frustrated electorates, are making things worse. Jacques Cailloux, chief European economist of Royal Bank of Scotland, stresses the errors in a recent paper. Eurozone leaders have, he charges, failed to understand the scale and nature of the crisis, played heedlessly to domestic galleries and focused on putting malefactors in the dock, even though bad lending is as culpable as bad borrowing. He is right. Now, he adds, two new elements have entered: first, German opinion is turning against their central bank; and, second, a number of politicians, including Mark Rutte, Dutch prime minister, are suggesting the possibility of forced exit.

Yet the point of the currency union was that it was irrevocable. The supposed benefits depended on that. Any talk of exit reintroduces currency risk. Moreover, argues the RBS paper, “we cannot see any policy announcement ... that could successfully reduce the risk premium on exit back to negligible levels”. Now investors confront sovereign debt, financial and exit risks. The results will include runs on sovereign and bank debt, and even the disintegration of the capital market into national components.

Yet, once the taboo has been broken, the possibility of exit must be examined. So is it possible, or even desirable? Any such discussion has to start with Greece. Nouriel Roubini of the Stern School, New York University, has argued in the Financial Times this week that Greece should both default and exit. I have no difficulty in accepting the first proposition. Few can still believe that a huge reduction in the country’s public debt can be avoided. It is a question of when, not if.

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