The Future of the Euro (Part V)

Here is another article--this one from the New York Times-- suggesting the current economic crisis may ultimately force some countries off the Euro. Some observers like Willem Buiter and Barry Eichengreen dismiss such claims. Here is some of what Eichengreen has to say:

There is an alternative [to abandoning the Euro], namely fiscal retrenchment, wage reductions, and assistance from the EU and the IMF for the cash-strapped government.

To be sure, this alternative will be excruciatingly painful. No one will like it except possibly the IMF, which will relish the opportunity of reasserting its role as lender to developed countries. There will be demonstrations against the fiscal cuts and wage reductions. Politicians will lose support and governments will fall. The EU will resist providing financial assistance for its more troublesome members.

But, ultimately, everyone will swallow hard and proceed... [E]ven the most blinkered politicians will see what is at stake here. Investors would flee en masse from the banks and markets of a country that contemplated abandoning the euro. No matter how serious the crisis, politicians will realise that attempting to jettison the euro will only make it worse.

Dr. Eichengreen, one word: Argentina. This country tried fiscal retrenchment, wage reductions, and help from the IMF leading up to the 2001-2002 crisis. And yes, the leaders of Argentina realized that if they abandoned their dollar peg this action would likely lead to default and investors fleeing en masse from Argentina. But they still broke the peg. Commentator Brian over Willem Buiter's blog sums up this comparison best:

[I]f Argentina decided to leave the dollar, because it couldn’t take the pain of real depreciation without nominal depreciation, should we be that surprised if Greece (or more likely Ireland) shares a similar fate? The scale of the real depreciation required by Ireland, which has been amplified by sterling’s depreciation, looks particularly daunting.

See also Paul Krugman who makes a similar point here. History shows us that anything could happen, even a country leaving the Euro.