In May this year I send a copy of my recent book “L’euro: comment s’en débarrasser” to Martin Feldstein, as soon as it was published. In it I showed how the “Eichengreen sophism”, the claim that it was impossible for a country to exit from the Euro system because it would lead to a major depreciation of the newly re-created national currency, and thus to a catastrophic increase of the burden of previously issued euro-denominated debts, could be bypassed.
A depreciation of the euro exchange rate to the dollar (or the yuan) preceding the re-creation of a national currency (a euro exit) would make a major depreciation of the new currency, a new Franc for instance, unnecessary. Accordingly, no increase in the Franc value of the euro denominated debts would be entailed by a euro exit, and the “Eichengreen burden” would vanish.
Now Martin Feldstein, who previously advocated a temporary sabbatical for Greece from the euro, in order for that country to regain some external competitiveness, only to return to the fold of the euro system later on, advocates another type of solution in an FT op-ed titled “A weak euro is the way forward” (December 19, 2011). Basically he reproduces the analysis that I develop in my book. Looking for “the action that can shrink the current deficits of Italy, Spain and France without austerity, internal devaluations, or German expansionary policies” he finds a solution “in a lower value of the euro leading to an improved trade balance with countries outside the eurozone”. “Declines of the euro’s trade-weignted value will cause the exports of all eurozone countries to rise and the imports from outside the region to decline.”
How far should such a decline proceed?
“It is not clear how much further the euro would have to fall to eliminate existing current account deficits but it might take a trade-weighted decline of 20 per cent or more. That could imply a euro-dollar exchange rate below its initial value of $1.18 per euro.”
In my book I explain that a return to that parity would be necessary and that a return to the 2001 value of $0.85 would be even better, considering that the annual average growth rate of the eurozone at that time was a solid 4 per cent.
Is that target unrealistic? I do not think so. The euro lost about 25 per cent of its value between 1999, when it was introduced, and its lower bound of 2001. What is required today, after its 12 per cent decline since the beginning of 2010, is a further decline from $1.30 to $1.00 for instance (a 23 per cent decline) or even better to $0.85 (a 34 per cent decline).
How to obtain such a decline of the euro? My argument is that beyond money creation by the ECB, which the German government opposes, the growing doubts about the euro’s future effectively work to weaken the European currency’s value. And the further the delay in finding a solution to the current crisis, the greater will be the fall in value of the euro. Feldstein also cryptically notes that: “the recent momentum alone might cause that to happen.”
In conclusion, it is a pleasure that such a distinguished colleague finally comes to the same analysis that I proposed a few months ago. Of course it would have been more rewarding had he quoted my work and recognized that I originally suggested such a solution. But I trust knowledgeable readers in the blogosphere to make the necessary attribution, even in the American-centered world of professional economists.