September 12, 2006by Sebastian Dullien
In today’s FT, John Kay comments on the question whether a single country (he chooses the example of Italy) can leave EMU . He argues that while it would be highly complicated to determine how single contracts would be changed from the euro to a new lira, after a long hassle, lawyers and bankers would find a solution if there was a political will.
Concerning the technical problems of leaving EMU, I would be even more optimistic than John Kay. After all, there is a precedent for leaving a fixed exchange rate regime with a high degree of foreign currency denomination of contracts, liabilities and assets: Argentina. The country pulled out of a currency board in the crisis of 2001/2002. Prior to this step, the government had spent years to explain to the people that “one peso is one dollar and one dollar is one peso”. People had taken this to their heart. There was a coexistence of payments in dollars and pesos as well as contracts denominated in both currencies. People sometimes paid in dollars and got their change mixed in small peso and dollar bills.
Argentina pesofied its economy rather swiftly
The change back to the peso went relatively easy: In the crises of 2001/2002, the government just passed a number of laws saying that all liabilities are to be converted in pesos. In addition, the country defaulted on its debt. While both measures took a long time to be finally settled in courts (and international arbitrage for foreign bond holders), economic activity started to gain traction very quickly again – with pesos as the main mean of exchange. And – without much work of lawyers and bankers – the laws were basically passed overnight.
Contrary to what most economists predicted at that time, the Argentine experiment did not end in chaos and hyperinflation. Supported with a number of price freezes, the inflationary impact of the devaluation remained limited.
When I travelled to Argentina in early 2003, one year after the crisis, the economy was up and working again. Dollarization had almost completely disappeared and the pre-devaluation recession had been replaced by a smooth recovery. By now, the country is its fifth year of strong growth. If you compare today’s GDP to the level of 2001, just before the crisis, in which output dipped by more than 10 percent, the Argentine economy is actually doing better than that of its neighbour Brazil. Unemployment is at its lowest level for almost ten years.
The interesting fact about the Argentine de-pesofication is that at the time, politicians did not seem to have much of a plan of what they were doing. Nevertheless, they managed to engineer a rather working exit of the currency board (even though I have to admit that economic policy could have done better since than, relying less on populist measures to rein inflation and maybe apply the traditional brakes of restrictive fiscal policy). This proposes that leaving a monetary union might technically much easier than many people think.
Cultural linkages between Italy and Argentina
What might make Argentina a possible role model from the perspective of populist Italian politicians is not only that it pulled out of a fixed exchange-rate-regime rather successfully, but also the cultural and ethnic linkages between the two countries. A lot of Italians immigrated to Argentina. Once you come to Argentina, you will not only taste the Italian influence in the Argentine cuisine (as it is much better than those of its neighbors and rich in pasta and pizza), but you will notice it also in the sound of the Spanish spoken. Many Argentines still have relatives in Italy, and prior to the crisis 2001, Italians small investors had heavily bought Argentine bonds. Italians follow more closely what happens in Argentina than most other Europeans.
I am not saying that pulling out of EMU would be a good option – neither for Italy nor for the rest of the euro-zone. Frankly, I believe it would be catastrophe for Europe. However, technically, it might be rather easy. We all who are in for a united Europe will have to address populist critics of EMU with better arguments.