For the past week, much of Germany has gone on vacation—including Chancellor Angela Merkel—which means that the crisis in the euro zone has been put on temporary hold until Wednesday. Oh, sure, Spain is still in trouble and the continent is mired in recession and it's not clear whether European Central Bank chief Mario Draghi's plan to hold the euro zone together will even work. But, for the time being, the panicky headlines have gone into remission.
So, we'll just have to occupy ourselves with this dire policy brief (pdf) from Anders Åslund of the Peterson Institute for International Economics. Like many analysts, Åslund believes that a dissolution of Europe's currency union would be utterly disastrous. But he thinks that breaking up the euro would be far more disastrous than most economists assume. To explain, he takes a short jaunt through history.
His paper starts by noting that there have been plenty of currency unions in Europe over the past century. Czechoslovakia was technically a currency union that broke up (relatively painlessly, it turned out). But the three examples most relevant to the euro crisis, Åslund argues, are the breakup of the Habsburg Empire in Austria-Hungary in 1918, the dissolution of the Soviet Union in 1991, and the breakup of Yugoslavia. All of those were total economic fiascos:
All three ended in major disasters, each with hyperinflation in several countries. In the Habsburg Empire, Austria and Hungary faced hyperinflation. Yugoslavia experienced hyperinflation twice. In the former Soviet Union, 10 out of 15 republics had hyperinflation.
The combined output falls were horrendous, though poorly documented because of the chaos. Officially, the average output fall in the former Soviet Union was 52 percent, and in the Baltics it amounted to 42 percent. According to the World Bank, in 2010, 5 out of 12 post-Soviet countries—Ukraine, Moldova, Georgia, Kyrgyzstan, and Tajikistan—had still not reached their 1990 GDP per capita levels in purchasing power parities. Similarly, out of seven Yugoslav successor states, at least Serbia and Montenegro, and probably Kosovo and Bosnia-Herzegovina, had not exceeded their 1990 GDP per capita levels in purchasing power parities two decades later. Arguably, Austria and Hungary did not recover from their hyperinflations in the early 1920s until the mid-1950s.
Many economists have dismissed these examples as irrelevant, Åslund writes, by arguing that these were all very different situations from the current euro zone. After all, the former Yugoslavia was wracked by war. The post-Soviet economies were going through wrenching changes in the transition away from communism. Surely no one thinks Germany would have the same problems as post-Soviet Russia, right?
Yet Åslund argues that these examples are surprisingly relevant. Those three currency unions all involved a centralized payments system that had built up large imbalances and were then disrupted by a chaotic exit. Once the currency unions started coming undone, there was no mechanism for an orderly exit. New national banks formed and quickly started issuing their own currency, and the competition between banks generated hyperinflation. It's not hard, Åslund writes, to envision a similar scenario for the breakup of the euro.
Estimates of how gruesome a euro crack-up would be seem to vary widely. Citigroup's Willem Buiter says a euro zone split would "trigger a global depression that would last for years, with GDP likely to fall by more than 10 per cent.” Others suggest even bigger losses, with an economic collapse of up to 9 percent in the first year alone. But Åslund wonders if these estimates might even be too optimistic. Because the euro zone's centralized banking system has no mechanism for allowing countries to leave, he argues, a breakup is likely to trigger the sort of hyperinflation that plagued the Habsburgs, the Soviet Union and Yugoslavia.
In fact, he argues, if even one country left — whether a troubled country like Greece or rich country like Finland — that would trigger a chain reaction that would eventually split the whole euro zone: "The exit of any single country from the EMU, at the present time when large imbalances have been accumulated, would likely lead to a bank run, which would cause the EMU payments system to break down and with it the EMU itself."
Bad news. In the end, Åslund argues, if euro zone members really, absolutely have to split up, they should do so as quickly as possible, and everyone should act together at once. Unfortunately, that's unlikely — any breakup would inevitably be a slow, reluctant process. And that's the worst of all worlds, since it would involve competing currencies causing havoc in the areas that are still using the euro.
So, Åslund concludes, "the Economic and Monetary Union must be maintained at almost any cost." Fixing the euro zone's structural problems won't be easy. But they might be preferable to ending up like the Habsburgs. Something for Merkel to consider, perhaps, when she returns from vacation on Wednesday to deal with the ongoing euro crisis.