The following contribution was authored by Mario I. Blejer, former governor of the Central Bank of Argentina and Eduardo Levy Yeyati, professor of economics at the Universidad Torcuato di Tella in Buenos Aires.
"The tensions between the euro zone's north and south and the complex and politically costly transfers of money required to dampen the euro crisis have led many people to think the unthinkable: saving Europe's common currency may require that some countries abandon it.
Indeed, talk about exiting the euro has intensified, particularly in southern eurozone countries that desperately need to regain competitiveness. But a look at what exiting the euro might mean in practice should stop such talk cold.
Adopting a stronger currency (as in 'euroisation') is neither difficult nor particularly unusual. Introducing a new, weaker national currency to substitute for a stronger one in times of financial distress is an altogether different matter, about which most economists know almost nothing.
The closest experiment along these lines is probably Argentina's exit in 2002 from its dollar exchange-rate peg (embodied in its currency board) to a floating regime that depreciated the peso by 300% in the first three months.
Despite Argentina's obvious differences from the euro zone's troubled southern economies, the Argentine currency rollercoaster provides sobering lessons for European policymakers to ponder. Do Europeans want to return to their own version of a flexible peso? At the very least, European policymakers will need to be willing to (a) 'pesify' contracts, (b) impose heavy restrictions on commercial banking operations, (c) restructure debts, and (d) introduce capital and exchange controls.
Consider each facet more closely. First, a new currency needs to create its own demand as a means in which to conduct commercial transactions by displacing the euro as sole legal tender and unit of account.
This, in turn, requires the forced redenomination of prices, wages and financial contracts, which can create serious disruptions, owing to heavy and asymmetrical balance-sheet effects, as well as a massive redistributive impact. Argentina's 'pesification' of bank deposits and loans benefited debtors at the expense of depositors, inciting public upheaval.
Second, should any eurozone country quit the euro, the anticipation of forced pesification is likely to set off a bank panic, as depositors quickly switch their pesified holdings back into foreign exchange in order to move them out of the system and probably abroad.
In fact, in Argentina, people started to withdraw their deposits almost a year before the exit from the currency board, fuelling capital flight and feeding back into market pressures to abandon the peg to the dollar – a dynamic that could be even faster and more furious in financially integrated European economies."
To read the op-ed in full, please click here.
Published in partnership with Project Syndicate.
