Sunday, December 19, 2010

Euro Defaults or Euro Exit?

“Far from being irrational, markets are quite right this time to be concerned about the current crisis in the euro area” writes Elena Carletti, a professor of economics at the European University Institute un Florence, in

As an alternative to sovereign default, she comments, a country could simply leave the currency union. “This would also need to be done quickly to avoid massive capital outflows. A government would have to redenominated overnight all contracts into a new currency, presumably at a 1-to-1 ratio with the original euro amounts. There would still be a market-determined exchange rate between the new currency and the euro.”

Would the following depreciation of the new national currency increase the burden of the foreign held government debt? Not necessarily.

“Most emerging-market sovereign debt was written under U.K. or New York law. In the euro area, much of it is under domestic stature. In Greece, about 90 percent is subject to local legislation.”

Presumably the euro denominated debt could be redefined as a national currency denominated one. But anyway, in my opinion, an exit by a single country would be much more costly both to the economy of that country and to big European banks if not preceded by a coordinated, and substantial, depreciation of the euro that would make a large devaluation of the new national currency unnecessary. And in any case, as I see it, (partial) default (or “restructuring”) and exit are not alternative solutions but could well prove to be complementary.

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