“JOEY, YOU GOT THAT LITTLE OLD DIME AND I GOT THIS BIG OLD NICKEL. BUT HERE’S WHAT I’M GONNA DO FOR YA...”

5/6/10

In the wake of the financial problems in Greece (See, by the way, my 2/10/10 post INGESTING THE FINANCIAL HEMLOCK for an early look at this latest “crisis.”), there is talk among some economic and financial observers of the demise of the euro. While the demise of the euro is not out of the question, the more logical, and foreseeable, outcome is, as numerous observers have pointed out, the shrinkage of the euro zone; i.e., the “strong” euro countries, such as Germany and France, will continue to use the euro while the “weak” current euro countries, such as Greece, Portugal, and Spain, will be shown the door.

But one has to ask how such a reversion away from the euro would be accomplished; it seems to this observer to be somewhat akin to trying to extract the ingredients from cake batter. One supposes that one could just declare that the currency of, say, Greece would, as of a certain date, no longer be the euro but instead the, say, drachma. Okay. So Greek citizens are supposed to exchange their euros for the brand new drachma. How long do you think the lines would be to complete the exchange from a currency anchored by the likes of Germany for a currency that was dragged back from the grave because its issuer was unable to maintain even a semblance of fiscal discipline, even by the increasingly lax, and/or ignored, rules of the eurozone? Being a believer in free markets, I am reasonably confident that there would be a market clearing exchange rate, but what would constitute “market clearing”? The rate at which every Greek is willing to abandon his or her euros for drachmas? Good luck. The rate at which the majority of Greeks would exchange their euros for drachmas? Such an outcome is far more likely than a “complete” exchange, but how low (or high, depending on one’s side of the trade) would that exchange rate be? Are we talking ‘80s Latin American “exchange” rates here? Perhaps. Even barring such a cataclysm, one can expect, or perhaps hope, that there would be a period of time when the two currencies would trade in a parallel fashion and Greece (and the other euro “exile” countries) would have, for most intents and purposes, two official currencies until the public becomes comfortable with the drachma. But suppose that day never comes, that the Greeks never achieve such a degree of comfort with the drachma. Suppose that the euro, which surely would be no powerhouse itself in the wake of the eurozone’s ignominious contraction, wins out in the currency competition and the drachma just fades away. What then? Further, what happens to all those euro denominated obligations of Greek (and maybe Spanish, Portuguese, etc.) entities, public and private, when Greece no longer uses the euro as its official currency? The nosedive Greek bonds have taken so far will look like a mere stumble; 9% or 10% or even 12% yields on Greek ten year government bonds will look impossibly rich.

The problems of a shrinkage of the eurozone appear insurmountable. Ironically, it would seem easier to just junk the euro altogether and have all the euro countries go back to their old currencies, declaring a date on which the euro is no longer acceptable as legal tender, as was done with the deutschemark, franc, and lira when the euro was created, adding a degree of compulsion to the conversion to the new currencies. As long as the euro exists as an alternative, it’s hard to see any current euro country successfully unscrambling the egg and ditching the euro in favor of its new, or old, currency.

Or am I missing something here? The question is not rhetorical.