How to Break Up a Monetary Union – UBS
The Euro stays
We do not believe that European Monetary Union will break up. The costs of breaking up the Euro, at this stage, far exceed the benefits. Far better, in our view, to default within the Euro than to incur the political, economic and possibly social costs of trying to survive outside.
Monetary unions do break up
Notwithstanding the fact that we think the Euro survives intact, it is relatively clear that (in economic terms) the Euro does not work. That is to say, parts of the Euro area would have been better off (economically) if they had never joined. This is not an argument for departing, but it raises questions about the factors that make monetary unions economically successful, and what happens when those factors are absent.
Two monetary union fractures
Looking at the historical precedents of the US monetary union seizing up in 1933, and the collapse of the Czech-Slovak monetary union in 1993, may be helpful in considering what the Euro area will have to do over time if it is to become a more efficient monetary union.
The US precedent
There are some tempting parallels between the US situation in the 1930s and the position of the Euro today. The US monetary union, though it effectively ceased in early 1933, was able to re-establish itself by adapting its institutions. In particular, labor market mobility and fiscal transfers across borders were ultimately important in generating a more smoothly operating monetary area.
Germans should pay for Greek pensions
The concept of fiscal transfers across different regions within a monetary union normally suggests a degree of political union, though this does not have to be the case. What it does suggest, at least for now, is that popular complaints in Germany (and elsewhere) about paying for social security in other parts of the Euro area appear misguided. Monetary unions entail sense of economic community. This means that wealthier areas should, indeed must subsidize those parts of the monetary union that are at an economic disadvantage. Fiscal transfers are the price that has to be paid for a monetary union of any meaningful size.
With the background of the current economic and monetary problems that certain member states are having it is interesting to reflect upon how UBS viewed the applicants to the EMU in 1996. The Venn diagram below was put together by UBS as the EMU was being established.
For more on the Greek situation see the Wall Street Journal article, “Greece to Issue Bond Next Week.”
Background on the European Union:
Blue = EMU members Green= EMU II members Red= Other EU Members
Market Reactions to Debt Levels Differ
The first chart below, demonstrates how markets view the risk associated with holding the sovereign debt of a PIIG country by using the Credit Default Swap spreads. With this risk in mind it the second and third charts illustrate just how much debt countries are projected to add in 2010, Fig.3, and the level of gross public debt as a percentage of GDP in 2010.