What would a rump Eurozone look like?

17 December 2011


What was once in the recent past spoken only in a hushed whisper is now openly discussed and debated: the break up of the Eurozone. But what exactly does “break up” mean in this context? The term implies a catastrophic failure that is not likely to come about, however painful a Greek exit from the Euro would prove to all the Eurozone economies. The Economist Intelligence Unit is calling the Eurozone crisis “€urogeddon,” which seems a bit dramatic for the financial press. With dire news following day upon day it would be easy to be very pessimistic about the Eurozone at the present time, but I am not pessimistic, although the short term outlook is not good. Being able to distinguish the short term prospects of an institution from its long term prospects is crucial in this context.

What exactly would a “break up” of the Eurozone look like? Here is what the Economist Intelligence Unit says in their report, “After €urogeddon? Frequently asked questions about the break-up of the euro zone”:

Firm predictions are tricky, but broadly a fracture between a strong northern “core” and the weaker “periphery” looks most likely. The process would, in our view, probably entail periphery countries breaking off individually to leave a “rump” of northern countries still within a currency union. Once one peripheral country (say, Greece) left, all the other vulnerable countries would probably follow. This means that Portugal, Ireland, Italy and Spain would leave the euro, although not necessarily immediately. Malta would probably leave, and Cyprus would have little choice but to exit as its banking system would be nearly wiped out by a Greek collapse. Up to ten countries could remain members of the euro: Germany, France, Austria, Belgium, Finland, Luxembourg, the Netherlands, Slovakia, Slovenia and Estonia (the last three all being small, open economies like Malta and Cyprus, but with healthier fundamentals).

It is interesting to me to see how this analysis — which I believe to be entirely reasonable and defensible — follows the principle of distinguishing center and periphery, which is something that I have been thinking about recently, and which I wrote about in The Farther Reaches of Civilization and The Second Law of Geopolitical Thought.

Thus a “break up” of the Eurozone would likely involve recession, riots, civil unrest, and bank failures (all these are also discussed in the Economist Intelligence Unit paper quoted above), but it would not be a catastrophic failure. We are not likely to see the dissolution of the Eurozone. The Euro currency will not only survive, but will eventually strengthen as the weaker and underperforming economies of the Eurozone leave the currency union and pursue a different — and marginal — economic path. The underperforming economies will devalue their labor, eventually attracting a little investment on the basis of this devaluation, and will more or less be relegated to a permanent twilight of an economy based almost entirely on tourism. (This is the obvious fate of Greece, and is likely the fate of Greece even if it remains within the Eurozone.)

A rump Eurozone would in fact be a healthier and more sustainable Eurozone than the current Eurozone, which attempts to treat underperforming economies the same as nearly optimal economies. The current Eurozone, with its peripheral members included, is like a cart pulled by two horses — a plough horse and a race horse yoked together. The financial markets are already anticipating this longer-term strengthening of the Euro. If the markets were expecting a catastrophic failure in which the Euro entirely disappeared and all the Eurozone member nation-states reverted to a national currency, we would see the Euro driven down dramatically. The Euro has fallen, but it still remains well within a ten year horizon of trading values. Nothing truly dramatic has happened to its value. If a catastrophic failure was expected, the Euro wouldn’t be trading ten or twenty percent down from its highest value, it would be trading at ten percent of its highest value.

Euro exchange rate with the US dollar in the second half of 2011.

The Eurozone still remains one of the great socioeconomic experiments of human history — an experiment on a grand scale, like the Constitution of the US, which attempted to put Enlightenment-era values into actual practice as a political institution. We recall that the US, in the course of working through its experiment, has encountered some major obstacles, such as the Civil War. As it happened, the US did not break up, or even shed its underperforming regions; however, it maintained its unity only through force of arms. This is significant.

One of the radical and novel aspects of the Eurozone is that it has been voluntary; no military power was been employed either to establish the currency or to further the expansion of the Euro or to secure its ongoing unity. We cannot place too much importance upon this unique historical fact. The very existence of the Eurozone is a living and vital rejection of the Stalin Doctrine. This is not only historically unusual in global terms, it is remarkably at variance with European history itself, which has been unparalleled in its violence and bloodshed.

Because the Eurozone is voluntary, it can afford to be flexible over the long term. It may not have been initially conceived as a flexible institution that could grow or shrink as political and economic conditions change over time, but I think that it could become something like this. Even while the peripheral economies may fall away, several nation-states continue with their accession process to join the Euro. From the experience of the Euro so far, we can more or less predict which economies will be able to successfully join the Euro, deriving a benefit thereby, and those economies which cannot successfully function as a part of the Eurozone.

The voluntary and egalitarian nature of the Eurozone will not vanish with a Greek default and exit from the currency union, even if the exit of Greece takes another member states out of the currency union at the same time. In fact, it could be argued that the experience will make the Eurozone more voluntary and more egalitarian. If the Eurozone comes to include formal protocols both for entering and for exiting the Eurozone, the voluntary nature of the association will have taken a step toward rationalization, and the Europeans will have accomplished something that the US was not able to accomplish: peaceful succession.

I am optimistic that the Eurozone (under the security umbrella provided by overwhelming US military force) may become one of human history’s first truly intelligent institutions. In some earlier posts I made a distinction between the grades of flexibility in institutions, and suggested that humanity might someday be capable of living under intelligent institutions which can take account of their own need to change over time, and the effect this change intelligently and peacefully, rather than being dragged kicking and screaming into the future. The Europeans have proved that they can learn from history, and have demonstrated this by peacefully creating and living within the Eurozone. If they can learn to live without solving problems through force of arms, there is hope that they can also learn to live with truly egalitarian, flexible, and intelligent institutions that can learn from past mistakes and incorporate change into the very structure of that institution. Time will tell.

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Note Added 04 July 2015: While the above was written years ago, the analysis is still more-or-less accurate, and I can stand by most of the claims I have made. I have further elaborated on the past difficulties and future economic possibilities for Europe in the following posts:

Poor Cousins

The Economic Future of Europe

An Alternative to the Euro

The Dubious Benefits of the Eurozone

Shorting the Euro

Will the Eurozone enact a Greek tragedy?

A Return to the Good Old Days

Can collective economic security work?

What would a rump Eurozone look like?

The Old World in Turmoil

Gibbon, Sartre, and the Eurozone

Europe and its Radicals

Default in the Eurozone

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Grand Strategy Annex

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project astrolabe logo smaller

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