Without a European sovereign, no real budget; and without a budget, no viable economic policy. As long as Europe does not emerge from this dilemma, the euro area will remain stuck in the vicious circle of stagnation, resentment and conflicts of responsibility. If fiscal federalism is out of reach, then it is crucial to be able to adjust exchange rates to boost growth and employment by leaving the monetary union.
Nevertheless, two difficulties are generally opposed to the abandonment of the euro. The first concerns short-term disruptive effects on trade flows and prices. There is little doubt, however, that the new parities would soon make it possible to eliminate imbalances and stimulate the activity of the countries which have suffered the most in recent years. Moreover, the pre-deflationary context would help to contain the effects of imported inflation in devaluing countries.
The second objection concerns financial interpenetration. It would be so advanced that the dismantlement of the euro or even the exit of a single country would have cataclysmic consequences on the balance sheets of economic agents. In a recent study ("Balance sheets after the EMU: an Assessment of the Redenomination Risk", Working Paper, OFCE, 2016) we examine this issue in detail and draw three main lessons.
The first is that the exposure of the different sectors is much less than is generally imagined. First, because the bulk of the balance sheets is backed by national law contracts, the corresponding financial commitments will be easily converted into the new currency, without affecting the solvency of domestic agents. Secondly, the risks associated with a devaluation due to the increase in the weight of bonds under foreign law or contracted in foreign currencies must be downplayed by the fact that foreign assets are revalued, though we acknowledge that agents are not uniformly protected by their international assets. Lastly, all liabilities do not constitute a problem. The crucial element is international debt and, in particular, short-term debt that can cause serial defaults if its weight increases sharply in the event of a devaluation.
Once these elements are taken into account, and this is the second lesson of this study, it appears that there are few countries and sectors that are truly vulnerable. Greek and Portuguese public debts, as well as the debt of the Greek financial sector, will inevitably have to be restructured in the event of a euro exit, but it is already well-known that their sustainability is questionable.
For the rest, the risk of redenomination concerns mainly small economies whose financial sector is highly developed and highly internationalized, notably Luxembourg, whose external position represents more than 180 times its gross domestic product (GDP), as well as Ireland and the Netherlands. Thus, the non-financial sectors of the various countries have a low exposition, suggesting that an exit from the euro or a dismantling of the zone will not, as such, have major consequences on companies' balance sheets.
Take the non-financial private sector in France. At the end of 2015, the debt vulnerable to a redenomination represents 33% of GDP (17% in the short term), but international assets account for 74% of GDP. Assuming a devaluation of 11%, the weight of short-term debt would increase by 2% of GDP (3.7% for total debt), which is large but limited. Especially since, at the same time, the value of international assets expressed in terms of national currency increase (+8.6% of GDP), which means that, ultimately, private agents would be richer in national currency in case of an exit from the euro (4.9% of GDP).
What is most to be feared are turbulences in the financial sector. In addition to a monetary policy that ensures the integrity of the payment system and the temporary establishment of capital controls to counteract speculation, public banks will have to facilitate access to credit for the most directly exposed firms and guarantee the access of firms to foreign currency for essential imports. If these precautions are important, what our example shows above all is that the wealth effect of a redenomination followed by a devaluation can stimulate economic activity.
The third lesson of this study is that the consequences on the balance sheets concern both the countries which will have to devalue—and will therefore see their international liabilities expressed in local currency increase—than the countries whose new currency will appreciate with respect to the current value of the euro—they will see their international assets expressed in their new national currency lose value.
This point is extremely important because it gives a premium to cooperation between the different countries : on the liabilities side or on the asset side, it is in the interest of both parties to cooperate to prevent foreign exchange over-adjustments. To prevent the financial turmoil, negotiations should also focus on restructuring excessive public debts and reducing the hypertrophied financial sectors.
On the economic front, a total or partial dismantling of the euro would create a new incentive structure conducive to genuine cooperation in Europe. While the architecture of the single currency promotes competitiveness policies that tend to oppose different countries and fuel deflationary tendencies, its rethinking would restore the bargaining power of debtor countries and promote a rebalancing in favor of the development of the productive sector and of employment. The analysis of the adjustment of the balance sheets thus confirms the diagnosis of Joseph Stiglitz : abandoning the euro can help save Europe.
First published in Le Monde on 1 March 2017