Wednesday, April 20, 2005

The Euro is at risk ?

Joachim Fels at Morgan Stanley is going to be courting as much controversy with his latest comment Euroland - Euro at Risk as he did with his Eurowreckage analysis early last year.

I believe he makes some valid points.

Here is part of his comment which relates to Germany withdrawing from EMU. I would however recommend a reading of all of it at the above link to put in context.

How could EMU break apart? As I see it, the most likely break-up scenario entails a weakening of the ‘stability consensus’ within the union, with sharply rising fiscal deficits in some countries and increasing political pressures on the ECB to create higher inflation in order to erode the real value of government debt. Naturally, the ECB would likely put up a tough fight initially, but eventually it is difficult to see how it could stem against a loss in the stability consensus that we assume in this scenario. High fiscal deficits and rising inflation could then lead to a wave of protests in countries which have historically had a high preference for price stability, such a Germany. One or several political parties could then jump on the issue, promising to lead the country out of the ‘instability union’ by introducing a New Deutschmark, which would be internally and externally more stable than the euro. Of course, a credible threat of a large country to withdraw from the euro might already bring about a change in policies in the union at large. However, depending on the political constellations elsewhere at that time, some other governments or parties could well choose to embark on a ‘national-interests-first-campaign’ as well, spelling the end for the single currency. As I spelled out in more detail in the Euro Wreckage? piece last year, the technical and legal hurdles to re-introducing national currency are fairly low, in any case.