Nobody quite seems to want to say it yet, but the growing Spanish and Italian bond spreads make me really think that barring a quite dramatic change in Angela Merkel’s thinking, the Eurozone is heading for a break up. But one of the big question marks around this is how it would actually work logistically. Nick Rowe gives us something about why it would work if you could pull it off:
It’s easier to think about currency reform in the Eurozone. In fact, currency reform is probably coming, whether anyone wants it or not. Eurozone governments and banks that cannot pay their obligations in Euros may end up paying their obligations in a scrip that is not pegged to the Euro. A scrip issued by each national government that is worth whatever people think it is worth. And if people start using that scrip as a medium of exchange, and medium of account, it becomes a new money. Sure, Greek supermarkets might prefer payment in Euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves. And the supermarkets’ suppliers might prefer payment in Euros, but it’s either accept New Drachmas or let the vegetables rot in the fields. And the workers picking the vegetables might prefer payment in Euros, but it’s either accept New Drachmas or nothing.
In the Eurozone, if pessimists like me turn out to be right, currency reform will happen volens nolens. Though it would probably be better if governments recognised the inevitable, and adopted currency reform sooner rather than later.
Basically, as long as you can pay taxes with the new scrip, then the scrip has some kind of value and people will take it at some price. Issuing said scrip will allow Greece, Portugal, Spain, etc. to reflate their economies. This won’t change the fact that all these countries need to take a real hit to their living standards (part of the point here is precisely that the new currencies won’t be as valuable) but you won’t be in the absurd condition of having 21 percent of the Spanish workforce simply idle and unemployed. Of course one wrinkle in this plan is that attempted default by southern European countries could, in principle, lead to a German bid for continental military domination to force repayment of debts. But resisting such an attempted conquest is the only time-tested way of reflating the English and American economies, so even that might be for the best.*
* NB: Great power conflict would not actually be for the best. Many people would die.