A Greek divorce may prove less costly

by Edward Chancellor

Financial Times
May 20, 2012

The British foreign secretary Lord Palmerston once quipped that only three people knew the answer to the Schleswig-Holstein question; one was dead, the other had gone mad, while he himself had forgotten it. The crisis of the eurozone is just as perplexing. One possible solution requires massive fiscal transfers from northern Europe to the southern periphery. Italy has pursued such a course in the century and a half after its own political and monetary unification. The results have not been edifying.

There are four potential outcomes for Europe, according to a recent report by Morgan Stanley. The best result would be for the various members of the eurozone to experience both a political and economic convergence in the years to come. Given recent events, such a happy resolution to the crisis seems implausible. A second possible outcome is for the eurozone economies to converge without a full-blown political union. However, economic reforms take time to bear fruit and austerity in the periphery of Europe is proving to be politically dangerous. In order to regain competitiveness with Germany, Spain needs to cut its labour costs by 20 per cent or more. An internal devaluation of this magnitude is impossibly painful in a country where a quarter of the workforce is idle and non-financial private sector debt exceeds 200 per cent of GDP.

If members of the eurozone cannot find the political will to hold together and their economies continue to diverge, then a third outcome suggests itself. The economic and financial costs and legal complexity of dissolving Europe’s monetary union are incalculable. What would be the legal status of trillions of euros of euro-denominated over-the-counter derivatives and other intra-eurozone financial liabilities? Would the dissolution of the single currency mean the end of the European Union?

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