A Primer on the Euro Breakup

Below are the excepts and details from John Mauldin's Outside The Box weekly publication title A Primer on the Euro Breakup featuring Jonathan Tepper coauthor of the End Game with Mauldin. (PDF format at end of detail)


Many economists expect catastrophic consequences if any country exits the euro.  However, during the past century sixty-nine countries have exited currency areas with little downward economic volatility.  The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit.  The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises.  Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable.  Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).


Key Conclusions

• The breakup of the euro would be an historic event, but it would not be the first currency breakup ever 
• Previous currency breakups and currency exits provide a roadmap for exiting the euro
• The move from an old currency to a new one can be accomplished quickly and efficiently
• The mechanics of a currency breakup are surprisingly straightforward; the real problem for Europe is overvalued real effective exchange rates and extremely high debt
• Peripheral European countries are suffering from solvency and liquidity problems making defaults inevitable and exits likely
• The euro is like a modern day gold standard where the burden of adjustment falls on the weaker countries
• Withdrawing from the euro would merely unwind existing imbalances and crystallize losses that are already present
• Defaults and debt restructuring should be achieved by exiting the euro, re-denominating sovereign debt in local currencies and forcing a haircut on bondholders
• All local private debts could be re-denominated in local currency, but foreign private debts would be subject to whatever jurisdiction governed bonds or bank loans
• The experience of emerging market countries shows that the pain of devaluation would be brief and rapid growth and recovery would follow