Why a collapse of the Eurozone must be avoided

With markets in rally mode this summer, investors have forgotten on the possibility of a Europe break up. If this was to happen, the consequences would be so big, that actually the only option left is to save the Eurozone, whatever the price. From Voxeu.

Articles on a possible breakup of Eurozone either see it as a mere devaluation (Lachman 2010, Roubini 2011) or reckon that its collapse would amount to a major economic disaster (Buiter 2011, Cliffe et al. 2010, Normand and Sandilya 2011). It seems the latter is more likely. Large imbalances have accumulated between southern debtor countries and northern creditor countries. Any capping of these balances would disrupt the payments mechanism between the Eurozone countries and impede all economic activity (Åslund 2012).

In the last century, Europe saw the collapse of three multi-nation currency zones, the Habsburg Empire, the Soviet Union, and Yugoslavia. They all ended in major disasters with hyperinflation. In the Habsburg Empire, Austria and Hungary faced hyperinflation. Yugoslavia experienced hyperinflation twice. In the former Soviet Union, ten out of 15 republics had hyperinflation (e.g. Pasvolsky 1928, Dornbusch 1992, Pleskovic and Sachs 1994, and Åslund 1995).

The output falls were horrendous and long lasting. The statistics are flimsy, but officially the average output fall in the former Soviet Union was 52%, and in the Baltics it amounted to 42% (Åslund 2007, 60). Five out of twelve post-Soviet countries – Ukraine, Moldova, Georgia, Kyrgyzstan, and Tajikistan – had not reached their 1990 GDP per capita levels in purchasing power parities by 2010. 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 (World Bank 2011). Arguably, Austria and Hungary did not recover from their hyperinflations in the early 1920s until the mid-1950s. Thus half the countries in a currency zone that broke up experienced hyperinflation and did not reach their prior GDP per capita in purchasing power parities until about a quarter of a century later.

Full article here.