At its birth, economist soothsayers predicted a short life for the euro. For once, the economists might well be right. The man who might have the best paternity claim for the euro, Oskar Lafontaine, the finance minister for Germany at the time of its creation, recently repudiated it and called for a breakup of the currency zone as essential to diverting the southern European countries from “disaster.” Now, a book by economics professor Joao Ferreira do Amaral of Insituto Superior de Economia e Gestao called “Why We Should Leave the Euro” is sitting on top of the best-seller lists in Portugal, and generating a lively debate in that country about the costs of eurozone membership.
Portugal has done everything to meet the conditions for its $101 billion bailout from the International Monetary Fund and the European Union. It is now in its third year of recession, and unemployment continues to grow, reaching 18 percent, with little prospect for improvement. Membership in the eurozone, which makes many of Portugal’s exports relatively expensive and, therefore, uncompetitive in the global market, adds to that nation’s woes, as it does to those of Greece, which continues to drown in debt despite an effective default on privately held bonds.
Exit from the eurozone is an option that can no longer be excluded from consideration, or even a full dismantling of the monetary union. A return to monetary independence would be a helpful first step, even though it is no panacea for Portugal or any other member of the eurozone.
Exit has several dimensions: the method and timing of the split, how effectively the nations manage their exchange rates, and the benefits that accrue from initial currency devaluation. The obvious historical examples to look to are the breakup of Czechoslovakia in 1993 and the devaluation of the CFA (the French acronym for African Financial Community) franc of the Western and Central African countries in 1994.
Czechoslovakia broke up in a two-step process. The Velvet Revolution led to the political split establishing the independent Czech and Slovak nations on Jan. 1, 1993, with the expectation of a continued monetary union. That collapsed swiftly, though, and in just over five weeks, the two nations also had independent currencies. The key to a successful monetary separation is swift implementation, with a large enough workforce to get the new currencies into circulation and the old one out in a very short time. The currency split was announced on Feb. 2, and completed a mere six days later. The issues are much more complicated in the case of an exit of just Portugal (or Greece, or both), and the scale would be many times more vast if there was to be a dissolution of the eurozone. Nonetheless, the problems are surmountable.
Just as the establishment of the euro was a monumental — but ultimately feasible — task, so is its dissolution. The final analysis, for the Portuguese, for the Greeks and even for the Germans, is whether it is more costly to keep the euro, or to return to the escudo, the drachma and the mark. As the euro has strengthened against the dollar, countries such as Portugal and Greece have suffered from the resulting overvaluation of the currency. As long as they stay on the euro, the only way to correct for the overpriced exchange rate is to reduce all other prices, including wages — a long and brutal process.
This is a process the former French colonies of West and Central Africa have already experienced. They are part of two monetary unions, collectively referred to as the CFA franc, which was tied to the French franc in 1945. The fixed rate worked well until the 1980s. Then came a series of external price changes that left the CFA franc grossly overvalued and exports tumbling. A devaluation in 1994 restored competitiveness for a few years, increased exports and improved the fiscal situation, but the gains from the devaluation were frittered away as commitment to reforms waned. In fact, just like the EU, the CFA franc zone countries have exhibited consistent failure to meet fiscal deficit targets.
The problems of the European Union countries are complex, and it would be delusional to think that a simple return to independent currencies and floating exchange rates would solve all economic problems rooted in bloated welfare states, high debt levels, a stifling regulatory regime and rigid labor markets. Nonetheless, Portugal and some of the other member states might well be approaching the point where — as the internal debate demonstrates — it is past time to question the benefit of staying in the eurozone.
Exiting the eurozone would give Portugal the option of repeating Iceland’s much shorter course of medicine for economic recovery, and hope for the almost 40 percent of its young people currently unemployed.
Nita Ghei is policy research editor at the Mercatus Center at George Mason University.