Another Great Depression?

Another Great Depression?

Another Great Depression?

Written by Katinka Barysch, 15 October 2008

by Katinka Barysh

Many observers have drawn parallels between the current economic crisis and the Great Depression of the 1930s. However, the stock market collapse of 1929 did not directly cause what turned out to be the deepest and most prolonged recession of modern times, ultimately ending in the Second World War. The blame lies with misguided macro-economic policies and protectionist reactions, such as the infamous Smoot-Hawley tariff of June 1930, which contributed to a collapse in international trade. The downturn that is now hitting the US and EU economies will fuel protectionist reflexes. But unless western countries are prepared to tear up the rulebook of the World Trade Organisation, their room for manoeuvre is in fact limited.

Trade flows will of course be affected by the current crisis: domestic demand in the US, UK and other big economies is falling, companies cannot get the credit needed to finance exports and imports, and high energy prices have been pushing up shipping costs (although pressures are abating as oil prices fall). The Economist Intelligence Unit predicts that world trade will grow by only 4-5 per cent next year. That is a lot less than the average of 8 per cent recorded in the previous five years. But it is nothing compared with the Great Depression when real world trade flows contracted by around 14 per cent.

Surveys show that support for free trade among Europeans has been in decline for a couple of years, as people have become more concerned about globalisation, and in particular the rise of China. But overall, Europeans still hold rather benign views on international trade: over 80 per cent of Germans, French, Italians, Poles and Spaniards think that growing trade ties are, on balance, good for their country. Remarkably, in the traditionally more liberal UK the share is lower, at 77 per cent, and in the US barely over half, according to a Pew Global Attitudes Survey published earlier this year.

With many EU economies descending into recession and unemployment rising, enthusiasm for foreign trade will of course diminish. People fearing for their jobs and incomes are often happy to blame outside competition. The worry is that protectionist voices are growing louder around the world at a time when the multilateral trading system is severely weakened by the collapse of the Doha trade talks in July. However, while there is little chance of Doha – or any other ambitious trade deals – being concluded before economic conditions improve, the risk of a full-scale protectionist backlash appears small.

Most European countries trade more with their EU neighbours than with the rest of the world. Intra-EU trade is governed by the strict rules of the acquis, which does not allow any tariff or non-tariff barriers. The current recession will weaken EU countries’ commitment to state-aid rules, competition policy, as well as the liberalisation of services sectors and network industries such as energy. But the economic downturn would have to become truly catastrophic for trade barriers to re-appear within the EU.

The EU’s hands are also bound when it comes to trade with the outside world. Since the Great Depression, the world’s trading powers have conducted eight rounds of multilateral trade negotiations. As a result, tariffs on almost all manufacturing imports into the EU are low. And there are strict rules governing the use of ‘safeguard’ measures (to guard against surges in imports) and anti-dumping and anti-subsidy duties (to punish overseas producers that sell at artificially low prices). The EU could of course stretch, bend or even breach these rules to give temporary reprieve to, say, car companies, steel makers or clothing manufacturers (until a WTO court ruling resolves the issue). But such actions would probably only affect EU trade at the margins.

The failure of the Doha round does not substantially alter the trade regime of developed countries. However, unlike in the EU (and the US and Japan), developing countries are applying tariffs that are a lot lower (in some cases 20-30 per cent) than what they legally agreed to in previous trade rounds. Countries such as Mexico, India, South Africa or Korea could ramp up their tariff protection without breaching WTO rules. European politicians, and the Commission, could then come under pressure to retaliate. Moreover, a heavily Democrat-controlled US Congress could be a lot more hawkish on international trade. The main risk then is not that the rich countries will abandon their WTO commitments on a grand scale. It is that angry exchanges about economics poison the political atmosphere and make it more difficult for countries to work together on other issues, such as climate change.

Katinka Barysch is deputy director of the Centre for European Reform.


Added on 21 Nov 2008 at 20:12 by Anonymous

Brilliant article

The Commission's economic forecasts are still too complacent

The Commission's economic forecasts are still too complacent

The Commission's economic forecasts are still too complacent

Written by Simon Tilford, 07 November 2008

By Simon Tilford

On the face of it, it appears churlish to accuse the Commission of complacency when it is forecasting no growth in the eurozone economy in 2009 and a deep recession in the UK. But the Commission has a tendency to be slow to downgrade its forecasts and its latest forecasting round is no exception. The Commission’s forecasts of economic stagnation next year – 0.2 per cent in the EU and 0.1 per cent in eurozone – already looks out of date. It is hard to conceive how either the EU or the eurozone will escape deep recessions in 2009. The indications of an unprecedented slump in economic activity are multiplying all the time.

Of the EU-15 economies, the Commission is probably right to be most pessimistic about Britain and Ireland, forecasting economic contractions of 1 per cent and 0.9 per cent respectively in 2009. There is no doubt that these two economies will be among the hardest hit within the EU. Both are experiencing huge falls in house prices, and their credit markets have effectively seized up. British consumers are easily the most indebted in the EU. The UK’s household savings rate was actually negative in the first half of 2008. If it were to rise back to its long-term average of 8 per cent over the next three years, the British economy would experience a deep slump.

But it is the Commission’s forecasts for a number of other member-states that stand out. Its forecasts for Germany and Spain look least credible, at zero and -0.2 in 2009 respectively. Germany’s economic strategy in recent years has been based almost entirely on export success combined with high domestic savings rates and low consumption. This leaves it hugely vulnerable to the unfolding economic crisis. The IMF expects world trade volumes to rise by just 2.1 per cent in 2009 and trade between the advanced economies to decline by 0.1 per cent. After appearing to hold up relatively well over the early part of 2009, German industrial orders are now in free-fall (falling 8 per cent in October), as most of the country’s key export markets are either in recession, or growing much less rapidly. Business expectations have fallen to their lowest levels since 1992. Germany’s specialisation in capital goods, chemicals and premium cars stood the country in good stead during the cyclical upturn in 2004-06, but with demand for all three in reverse, Germany has become very vulnerable.

Nor will the domestic economy come to the rescue. Germany has avoided the house price boom entirely and German households are not that indebted. But a recovery in domestic consumption has proved elusive. After falling steadily for over two years, unemployment is about to start rising, which will no doubt prompt Germany’s risk-averse households to further increase the proportion of their incomes that they save.

The EU’s forecast for Spain is also too sanguine. Spanish unemployment is rising very rapidly, industrial production is falling (by 8.8% in October), the pace of decline in house prices is accelerating and demand for Spanish exports is under severe pressure. The collapse in construction sector activity will impose a severe drag on the Spanish economy next year. In the circumstances, it is hard to see how the decline in output could be held down to as little as 0.2 per cent.

The Commission expects zero growth in both Italy and France. Italy and France have not experienced house price booms of the scale seen in Spain or the UK, but in both countries industrial production is under huge pressure, as a result of collapse in consumer sentiment and a big fall in export orders. Consumer and business surveys point clearly to recessions next year, rather than economic stagnation.

The IMF’s forecasts look more realistic than those of the Commission. It is forecasting a decline in EU output of 0.2 per cent and 0.5 per cent for the eurozone. This means recessions in Germany (0.8 per cent), Spain (0.7 per cent) and France and Italy (0.5 per cent and 0.6 per cent respectively.) The IMF was heavily criticised earlier in the year for allegedly being too pessimistic about Europe’s economy’s outlook, but it has been vindicated as the European economy slowed dramatically even before the intensification of the financial crisis in September.

The aggressive cuts in interest rates by the ECB and the Bank of England (BoE) over the last six weeks have come too late to have that much impact on next year’s economic growth. Interest rate reductions normally work with a lag of about 18 months. Some governments are at the limits of their borrowing capacity and can do little to directly stimulate economic activity by cutting taxes or boosting expenditure. But others have scope to offset the severity of the downturn. The EU urgently needs member-states that have run-up huge current account surpluses and which have strong fiscal positions to boost demand. Germany and the Netherlands are the obvious candidates. Their current account surpluses are not sustainable in the present climate, and they need to rebalance their economies. Germany, in particular, requires a far more significant stimulus package than the one put together by the German government, which will have a marginal impact. If the governments of big surplus countries fail to take concerted action, their surplus savings will condemn themselves and Europe as a whole to an even deeper recession.

Simon Tilford is chief economist at the Centre for European Reform

Germany: Between a rock and a hard place

Germany: Between a rock and a hard place

Germany: Between a rock and a hard place

Written by Simon Tilford, 19 February 2009

by Simon Tilford

Twelve months ago it seemed inconceivable that any member of the EU could face a sovereign debt crisis. It would have been the stuff of fantasy to argue that Ireland or Austria could be among those at risk. Such an outcome is now well within the realms of possibility. If one country suffers a crisis, that will not be the end of it. It would almost certainly trigger a wave of crises, plunging the EU, and especially the eurozone, into turmoil. There is nothing inevitable about this. But a way out requires Germany to show more vision.

Some eurozone member-states – Italy and Spain – are vulnerable because they have lost so much competitiveness and investors are sceptical they will be able to regain it. Others – Austria and Belgium – have disproportionately large banking sectors and/or banks with huge exposures to crisis hit regions such as Eastern Europe. For their part, Ireland and Greece have lost competitiveness and have very exposed banking sectors.

What is the way forward? One option might be for governments to start issuing eurozone sovereign bonds, rather than their own national bonds. This would help address the problem of poor liquidity that has bedevilled many of the smaller eurozone financial markets. And it would reduce borrowing costs substantially for most eurozone countries.

There are, however, a number of obstacles. German borrowing costs would rise, as it shared its credibility with the rest of the eurozone. Such a move would arguably let profligate countries off the hook. And, it might be difficult to ensure budgetary discipline in the fiscally weaker countries. Curbing the budgetary autonomy of individual governments would require a far greater degree of political integration in the eurozone.

These concerns highlight what many economists have always believed to be the inherent contradiction in economic and monetary union: the absence of a political union. However, the German government’s objection to the pooling of bond issuance – that it would cost Germany too much money – is a parochial one. The alternatives threaten to cost Germany (and Europe) much more.

The German finance minister, Peer Steinbrück, has indicated that there may be a case for support for hard-hit members of the eurozone. But he is mistaken if he thinks a fiscal crisis in one member-state would be a cleansing experience, with the chastened country receiving a highly conditional IMF-type bail-out, and the others learning the lesson of their errant ways. First, one sovereign crisis would almost certainly lead to others. The direct costs of the bail-out could be surmountable in the case of an Ireland or a Greece, but would pose a much bigger challenge in the case of larger member-states. Second there would be indirect costs to the German economy, which is enormously dependent on exports to the rest of the eurozone. The last thing the German economy needs is a further collapse in external demand.

Nor is this the worst case scenario. If Italy or Spain defaulted on their sovereign debt – perhaps as a result of the rest of the eurozone failing to agree a bail-out or attaching excessively onerous terms to one – the repercussions for the eurozone could be dramatic. For inflexible and sizeable economies, it is far from clear that default within the currency union is more plausible than a default and a move to leave it. A member-state could decide that having defaulted (and in the process cut itself off from most sources of capital, at least for a time) it may as well devalue, which would at least help to restore competitiveness and get the economy growing again. If one country were to leave, pressure on others to follow suit would be intense.

Germany cannot afford to be sanguine about such an outcome. German companies have spent years holding down costs. The result has been improved competitiveness versus the rest of the eurozone, but at the expense of chronically weak domestic demand. If the eurozone were to unravel, Germany would experience a huge real appreciation, reversing almost overnight the competitiveness gains it has painfully ground out.

A move to issue eurozone bonds would not mean Germany sacrificing its own interests for the good of Europe. A country as export-dependent as Germany and as politically reliant on the EU cannot afford to be blasé about economic crises in neighbouring countries. Germany is going to have to show solidarity one way or another, so it should do so in a way that imposes the fewest costs on itself and maximises its political capital.

Simon Tilford is chief economist at the Centre for European Reform.

Wij moeten de zwakke eurolanden helpen

Wij moeten de zwakke eurolanden helpen spotlight image

Wij moeten de zwakke eurolanden helpen

Written by Simon Tilford, 02 March 2009
From NRC Handelsblad

Financial regulation: Is the Channel narrowing?

Financial regulation: Is the Channel narrowing?

Financial regulation: Is the Channel narrowing?

Written by Philip Whyte, 27 February 2009

by Philip Whyte

On February 25th, a Commission-appointed taskforce headed by Jacques de Larosière published its much-awaited report on financial supervision in the EU. By coincidence, a parallel (but less widely reported) event took place the same day on the other side of the Channel: Lord Turner, the chairman of the UK’s Financial Services Authority (FSA), gave evidence to a parliamentary committee. What light does Lord Turner’s evidence shed on the UK’s likely reception of the Larosière report?

London’s status as a financial centre has long played an important role in Britain’s complex relationship with the EU. Although the UK has been a strong supporter of the single market, it has been suspicious of any moves that might undermine London’s position as Europe’s pre-eminent financial centre. London’s status has partly rested on the UK’s ‘light touch’ regulatory regime. And many in the UK have long worried that the survival of that regime is threatened by the encroachment of EU rules – particularly as countries such as France and Germany, which aspire to ‘repatriate’ business to Paris and Frankfurt, have never had the City of London’s best interests at heart. This explains why the City, the most cosmopolitan economic cluster anywhere in the EU, is relatively Eurosceptic. And it partly explains successive British governments’ reticence to EU integration.

However, the financial crisis is transforming some longstanding British assumptions. It is not that the crisis has reduced domestic Euro-scepticism. Domestic opposition to joining the single currency remains as strong as ever. But the crisis has called into question the merits of ‘light touch’ regulation. Popular feeling against financiers is running high. A backlash is in full swing. Bankers have fallen even lower in the public’s esteem than politicians, journalists and estate agents. Given the epic scale of the profits which have been privatised and the losses which have been socialised, the opprobrium financiers are attracting is understandable. All the main political parties are going along with the public mood. But it would be wrong to dismiss the recent furore as politicians pandering to the mob. For the change in British assumptions seems to run deeper: it is intellectual, as well as political.

Take Lord Turner’s evidence to the Treasury select committee. What did he say? In essence, he said that the era of light touch regulation was over. He promised a ‘revolution’ in financial regulation that would include tougher capital rules for banks, and capital and liquidity rules for previously large, unregulated institutions such as hedge funds. Asked about the way in which the FSA had supervised a bank which had to be bailed out in 2008 with taxpayers’ money, he said that it “was a competent execution of a philosophy of regulation that was, in retrospect, mistaken”. Lord Turner is no populist, so his testimony represents one of the strongest repudiations of the philosophy of light touch regulation to date. It would be wrong to conclude that the British have converted to the French and German view of financial markets. But the intellectual distance across the Channel has narrowed.

What of the British view on pan-European regulatory structures? The government has opposed periodic calls for the establishment of a pan-European regulator. And there is no reason to believe that the financial crisis has made it anymore keen on the idea. It will continue to oppose any blueprint that smacks of supranationalism. The question is: does the Larosière report propose institutional structures that the UK could accept? It is not yet clear. The Larosière group is not recommending that a single regulator be established. It has recognised that this would be unrealistic, given the absence of political appetite in the UK and some other member-states. So it has proposed building two separate structures: one dealing with traditional micro-prudential supervision (the oversight of individual institutions) and another with macro-prudential issues (risks to the financial system as a whole).

Micro-prudential supervision would build on existing institutional arrangements by establishing a European System of Financial Supervisors. The day-to-day supervision of institutions would be left to national regulators, and international colleges of regulators would continue to oversee cross-border banks. But there would be greater central coordination. The so-called Level 3 committees, which currently try to coordinate national regulatory approaches across the EU, would be given more powers and turned into new authorities for the banking, insurance and securities industries. Macro-prudential supervision would be carried out by a European Systemic Risk Council. This new body would be chaired by the European Central Bank (ECB), but composed of national central banks and regulators. It would collate and analyse information relating to system risk and financial stability.

Could the British government sign up to the institutional architecture proposed by the Larosière report? Although the report does not recommend the establishment of a single, pan-European regulator the British government may still find it difficult to cede new powers to EU bodies. The governing Labour Party is domestically weakened and, with only a year before the next general election, is trailing the opposition Conservative Party by a huge margin in opinion polls. The political context is important because Labour will not want to expose itself to accusations from Eurosceptic Conservatives that it has “given powers away to Brusssels”. The Channel may have narrowed, therefore. But it is far from clear that it has done so sufficiently to allow the Larosière report to be implemented. This is a shame, because there may be no other way to reconcile political constraints with the needs of the moment.

Philip Whyte is a senior research fellow at the Centre for European Reform.

Look who's sclerotic

Look who's sclerotic

Look who's sclerotic

Written by Simon Tilford, 28 September 2009
From International Herald Tribune

The real G20 agenda

The real G20 agenda

The real G20 agenda

Written by Katinka Barysch, 13 March 2009

by Katinka Barysch

Finance ministers from the G20 countries are meeting in London this weekend to prepare for the global economic summit at the start of April. Expectations are high. But what will the summit be about? Judging by recent comments from European leaders, the agenda will include clamping down on tax havens, regulating hedge funds and cutting bankers’ bonuses. Most commentators agree that these questions are not the most pressing for restoring financial stability and economic growth. Martin Broughton, president of the UK employers’ federation CBI, rightly dismissed them as “red herring issues”.

World leaders must focus two things: how best to work together to prevent an even deeper global recession; and how to avoid future crises of such magnitude.

The first issue is as pressing as it is divisive. While the US administration is pushing for more fiscal spending, the Europeans are reluctant, and most emerging powers are keeping quiet. Many countries are loath to commit to more budget spending before they know whether and how their existing emergency packages are working. The second part of the agenda is longer term and fiendishly complicated. No-one should expect an unwieldy group of 25 or so (G20 has become a misnomer) heads of state to discuss the minutiae of capital adequacy ratios or cross-border supervision. The G20 is a process, not an event, and this summit is a political exercise, not a technical one.

What the April meeting is really about is maintaining faith in multilateral solutions at a time when the temptation for go-it-alone and beggar-thy-neighbour policies is growing. If leaning on Liechtenstein or forcing disclosure onto hedge funds helps this cause then so be it. But in terms of confidence building two issues appear paramount: the role of the International Monetary Fund and governments’ commitment to avoid protectionism.

Since September 2008, the IMF has lent over $50 billion to countries ranging from Pakistan to Ukraine. It urgently needs more cash. The US and EU governments are supporting a doubling of the Fund’s resources to $500 billion. They appear less willing, however, to redress their own over-representation in international financial institutions. This would be a precondition for emerging powers such as China to contribute significantly to an increase in IMF resources, and – perhaps more importantly – accept its legitimacy at the heart of the global financial system.

The IMF needs enhanced legitimacy to fulfil other functions that will be equally essential for future financial stability. First, the world needs better surveillance of national macro-economic and exchange rate policies to address the kind of global imbalances that have contributed to the current crisis. The IMF already has such mechanisms in place but they need to be strengthened. Second, the Fund needs to expand its new, $100 billion short-term, conditionality-light lending facility for emerging markets that are well run. It could also encourage such countries to pool their foreign exchange reserves to make them available for emergency lending.

Without easily available emergency finance, emerging markets will conclude that the best insurance against future pain is to accumulate more reserves. They will do this by keeping their currencies down and running big external surpluses. This kind of policy, as practiced by China, has already caused lots of friction. In an environment where global trade is shrinking, it would fuel a nasty protectionist backlash in the West. That is why the G20 summit needs to produce a firm commitment to increasing the IMF’s role and resources while setting in train a thorough reform of its governance structures.

There are already some signs that protectionism is rising. World Bank economists have counted 47 new trade restrictions since late 2008. More than a third have been put in place by the G20 countries that pledged to avoid such measures at their November 2008 summit. But the real risk is not a return to a 1930s-style tariff war but what Richard Baldwin and Simon Evenett (in a recent CEPR paper) call “murky protectionism”: industrial subsidies, requests that banks lend to only local companies, or the use of environmental arguments to discriminate against foreign goods and services. Examples abound, such as the ‘buy American’ provisions in the US stimulus programme or Nicolas Sarkozy’s idea that French car companies should make cars only in France. Encouragingly, in these instances international outrage ensued and the governments in question backtracked. The risks, however, remain high.

Therefore, G20 leaders need to broaden the ‘no protectionism’ pledge from last November to cover non-tariff measures. And they need to task international organisations such as the OECD and the WTO with alerting the world to national measures that could be harmful for that country’s trading partners.

Katinka Barysch is deputy director of the Centre for European Reform.


Added on 30 Mar 2009 at 16:26 by Andrew Gibbons

Maybe it's time to establish or designate an independent referee organisation to assess the economic impact (i.e. the effective rate of protection) of any new trade policy measure by any country.

Not a new idea, but a non-partisan verdict on the implications of trade measures would bring objectivity and transparency to the debate -- and act as a disincentive for covert protectionism.

Added on 13 Mar 2009 at 21:54 by Aydin Sezer

Thanks Katinka,

We should admit that developed countries apply non-tariff measures, especially by using environmental arguments to discriminate against goods from developing countries. This is not a new policy in international trade.

How serious is the threat to the single market?

How serious is the threat to the single market?

How serious is the threat to the single market?

Written by Simon Tilford, 19 March 2009

by Simon Tilford

There has been a lot of anguished talk about how the EU’s single market is under threat. Much of this alarm has focused on government support for struggling car firms and public bail-outs of crisis-ridden banks. An erosion of the EU’s competition rules would be every bit as debilitating as the impact of the financial crisis and the resulting recession. But how serious is the risk to the single market?

On the face of it, there is plenty to worry those who see the single market as key to Europe’s future prosperity. First, any hope that the impact of the financial crisis on the ‘real economy’ would be limited has ended. In the face of huge falls in industrial output this year and the prospect of several years of very weak economic growth, many European industrial firms will go bankrupt. Wage subsidies and short-time working, and all the other strategies currently being employed to cope with the collapse of demand, can only be sustained for so long. Many of the firms that go bust will be fundamentally competitive, or at least appear so. EU governments will be under huge pressure to intervene to protect such companies. The way in which they intervene will be crucial. The Commission will have a real fight on its hands to ensure that competition is not distorted. It should be strong enough to enforce the rules. But much will depend on whether member-state governments support the Commission and on who is appointed to be the next EU commissioners for competition and the internal market.

Second, the landscape of European banking has changed fundamentally over the past year and competition policy in this sector has effectively been suspended. A number of the biggest EU banks have been nationalised in all but name and governments have moved to provide public guarantees for bank loans. The shot gun marriage of Britain’s Lloyds TSB with another high street British bank, Halifax Bank of Scotland (HBOS), has left the combined group controlling around a third of the entire UK market for consumer banking services. The German, Dutch and Belgian governments have bailed out financial institutions, while governments across the EU have recapitalised banks.

The dramatic increase in government influence over the lending process will need to be reversed if potentially serious distortions are to be avoided. There is a risk that pressure will be put on banks to maintain funding for national champions and to avoid lending to companies based in other EU states. Such politicised lending would undermine the efficient allocation of capital throughout the EU by protecting inefficient companies and reducing available funds for more competitive firms. Once the financial sector has stabilised and normal levels of financial intermediation have been restored, the Commission will have to get serious about ensuring that the EU does not retreat into such ‘capital protectionism’.

Third, a further deepening of the single market can be ruled out. Crucially, faster action to liberalise and integrate service sectors across the EU now looks out of the question. It was hard enough to gain consensus in favour of radical moves to dismantle obstacles to the integration of service sectors before the crisis, but it will be impossible in the face of the backlash against liberalisation. This is bad news. Service sectors account for around two-thirds of economic activity across the EU. Service sector productivity has been extremely weak for a number of years now, holding back economic growth. More competition at both national and European level would do much to change this, and boost economic growth.

The lack of service sector integration will be particularly damaging for the eurozone. Countries that decide to forego exchange rate flexibility as a tool of economic adjustment need to ensure that their economies can be flexible in other ways. If countries such as Spain and Italy are to recover their competitiveness within the currency union, they will have to boost their productivity. This, in turn, requires more competition in service industries. The alternative route to greater competitiveness – wage cuts – would condemn their economies to stagnation. And such wage deflation might not be possible in any case, as Germany is heading for deflation. It will be extremely difficult to cut costs relative to Germany, if German costs are falling.

The legal underpinnings of the single market appear robust. But there are real reasons for concern. The steady progress in reducing state-aid has been halted and is likely to be put into reverse. The partial renationalisation of bank lending is inimical to the emergence of a single capital market. And progress towards deepening the single market in services has ground to a halt. All this bodes ill for Europe’s growth prospects and the stability of the eurozone. All EU governments profess to be committed to upholding the single market. The next couple of years will determine the strength of that commitment. If member-states do not respect the Commission’s right to enforce those rules, the single market could indeed come under threat.

Simon Tilford is chief economist at the Centre for European Reform.


Added on 19 Mar 2009 at 12:23 by Andrew Gibbons

Simon is right to highlight the threats of government intervention to support businesses, non-market influences on bank lending and the stalling of Single Market reforms in the service sector.

There are also substantial threats to the principle of free movement of labour, both in government attitudes and at the more unpleasant end of the spectrum.

Germany's euro advantage

Germany's euro advantage

Germany's euro advantage

Written by Simon Tilford, 13 July 2010
From International Herald Tribune

What if the eurozone broke up?

What if the eurozone broke up?

What if the eurozone broke up?

Written by Tomas Valasek, 23 March 2009

by Tomas Valasek

The future of the euro may not be secure, warned the CER’s Simon Tilford in a January 2009 essay. The current economic crisis threatens to exacerbate the tensions within the eurozone, and an insolvent member-state... could default and leave the eurozone. Since January, the economic crisis has deepened further, and the eurozone’s weakest economies have come under even greater strain. This does not make their exit from the eurozone inevitable there is a strong argument in favour of keeping the eurozone together at any cost. But what if it did happen? What would leaving the eurozone mean in practice? What happens to the physical currency in circulation in the afflicted country?

There is a considerable body of precedents. Most historical currency unions have broken up. The most recent examples come from Central and Eastern Europe. Since the end of the Cold War, three countries with national currencies the Soviet Union, Yugoslavia, and Czechoslovakia have fallen apart, forcing their constituent parts to hastily adopt national currencies. To find out what the separation entailed, the CER spoke to an architect of one of those transitions: the former member of the board of the Slovak National Bank, Ján Mathes.

We asked him what a country leaving the eurozone would use instead of the euro. Several options are possible, Mathes said. Members of the eurozone have not kept a stock of national currencies in reserve so they would need to print and mint replacements. But if a country is in a hurry to leave the euro, there may not be enough time. Minting a sufficient number of new coins takes months. Producing today's high-tech, secure banknotes, from design to the printing stage, took Slovakia nearly a year. Even though eurozone members would need less time they would presumably revert to the design they used before adopting the euro printing hundreds of millions of notes still takes many months.

If a country left the eurozone abruptly, it would need to find temporary ways to separate its share of the euros from the rest. In the early 1990s, the Czech Republic and Slovakia chose to stick distinguishing stamps on their banknotes. We had thousands of people working day and night, putting tiny stamps on nearly 80 million old Czechoslovak banknotes, Mathes said. The Czechs affixed different stamps to their portion of the old notes and the currency was thus divided. Each side eventually printed its own currency, and the stamped notes were withdrawn and destroyed.

But what worked for the Czechoslovak koruna may not work for the euro. Stamps are easy to remove and the temptation to remove them would be strong. The value of the currency of the country leaving the eurozone is certain to plunge vis-à-vis the euro, so its citizens would remove stamps en masse, thus converting them to the more valuable original euros. Another physical solution, Mathes says, it to laser-engrave distinguishing marks onto the portion of the euros, which would have been allocated to the country departing the eurozone. This can be done relatively quickly and would make the currencies irreversibly different, said Mathes, adding “but I suspect that the European Central Bank will not look kindly on a state burning holes in its currency.

In many ways, the birth of the new currency would only mark the beginning of its troubles. A country would only resort to leaving the eurozone if it was in deep economic crisis but this guarantees that its currency will inspire little confidence. There is a risk that the currency’s value would slide uncontrollably. To prevent such a scenario, the new money would have to be introduced in tandem with a thorough stabilisation and recovery programme overseen and financed by the IMF or the World Bank.

But the same reforms, if introduced early, would also reduce the chances of a country dropping out of the euro in the first place. And the rest of the eurozone members will have strong interest to prevent anyone from leaving, because of the risks to the rest: a member's departure would weaken the credibility of the euro, deepening the sense of crisis and possibly forcing other countries to drop out. Self-interest may drive the rest of the eurozone to prop up the ailing country’s economy at nearly any cost. It is probably too early for ordering replacement currencies or burning holes in the euro.

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.


Added on 15 May 2012 at 23:09 by Anonymous

And yet, The Polish economy is bucking the crisis trend and its currency remains strong.

Added on 13 May 2009 at 13:14 by Anonymous

There are also historical precedents in the break-up of Austria-Hungary as a single currency zone - which involved the same 'stamping' type exercise of old banknotes.

The Czechoslovakia-EU parallel is unfortunate, however, is unfortunate: it is a favourite analogy of Vaclav Klaus. Was that intentional? As a parallel, it merits examination, but the difference may be that here we are talking about single countries exiting not (probably) the immediate collapse of whole zone. Remember also that the historical parallels are linked to the failures and break-up of multinational *states* and were primarily triggered by political not economic factors (above all nationalism and unworkable political institutions) states. The EU has an advantage in being a looser and messier political structure, not a classic state. Or does it?

Added on 24 Mar 2009 at 16:08 by King of Ithaki

greece operates much more like some central american banana republic than a modern state. 500 families control the vast majority of the economy and have allowed the discooperation that greece is famous for to secure their positions by insuring roadblocks to reform. In greece, there are many "grandfathered" properties and attempts to clean up ownership information by the EU is met with cartoonish responses. Instead of inspecting the records and drawing up factual data, the government repeatedly attempts to create a database where they just ask.."hew , what do you think you own ??" and encourage inter family fighting that spans generations, all in the name of keeping the status quo. Greece could physically hold 35 million people and has enough waterfront land to encircle the entire continent of africa. It's mountains provide stunning views and there could be construction work for 25 years which would create a huge economic boost and eliminate the need for brussels to finance the political incompetence and incontinence that disrupts progress in greece. But that would require the 500 families to look beyond their koboloys...and see a greece with a future, and not think about packing their finances into their KOTERA and sail off to Monaco.

Added on 24 Mar 2009 at 09:50 by Anonymous

Since when was the Soviet Union a country?

Added on 23 Mar 2009 at 15:13 by Anonymous

Not very helpful to project the failure of Czecho-Slovakia on that of the Eurozone. The former was federalism by dissociation the latter 'federalism' by association. If your concerne is now how to print again you national currency then it might have been wiser not to join euro in the fist place

Syndicate content