In the past few months, the likelihood of a Eurozone breakup has been escalating due to increasing tensions in the monetary union. The departure of problematic periphery countries like Greece from the Eurozone would have many implications onto Europe and the rest of the world. If the Eurozone were to break up, whether partially or completely, it would send the rest of the world into panic and economic turmoil. The countries departing the euro would have to revert back to its old currency and as such face a significant devaluation.
Thus people who have their savings in these countries would see a significant fall in value of their savings. In order to prevent this from happening, investors would withdraw their savings from the affected banks and sell their government bonds immediately. Therefore countries leaving the Euro would face a situation of significant capital outflows or capital flight. These capital outflows would dent investor confidence and may limit the ability of the affected banks to lend money due to liquidity shortage.
This ultimately will result in lower economic growth.
Having said so, the resultant devaluation of currency may not be a bad thing. It is a known fact that some Eurozone economies suffer from lack of competitiveness which has resulted in their weak growth in the recent years. By leaving the Eurozone and allowing their currencies to devalue, these countries can immediately boost the competitiveness of their exports without having to suffer through years of painful internal devaluation. After having increased their competitiveness significantly, exports will increase and higher economic growth can be achieved.
In addition to the initial capital flight from departing countries, a European credit crunch may occur. For instance, if Greece were to leave the Eurozone, the knock-on effects from a Greek bank run would threaten other European banks and financial institutions which have stakes in Greek banks. This is because the affected banks and financial institutions may suffer from a liquidity shortage as the Greek banks would be unable to repay the money borrowed from them. Meanwhile, the depositors in other Eurozone ountries which are seen to be at risk of leaving the Euro, such as Spain, Portugal and Italy, may transfer their money to the safety of a German bank account. This would spark a banking crisis in Southern Europe as banks suffer from liquidity shortages. Despite the negative outcomes of a Eurozone breakup, it is worth to note that it may be the best solution to the current debt crisis. At the moment, the crisis has reached the stage where it may no longer be both financially and politically feasible to keep the whole Eurozone together.
A prime example is Greece. Financially, the Eurozone may be better off letting Greece go, as efforts to reduce its national debt by offering exorbitant bailouts have been a huge drain on funds. Political wise, the Greek public has rejected the austerity measures imposed as a condition for the bailouts and have even voted for political parties which rejected austerity. Thus the funds used to bail out Greece can be better used on larger, more integral Eurozone countries which are more determined to reduce their debt levels.
Lastly, a Eurozone breakup may have adverse effects on the remaining member countries in the form of rising bond yields. This is because investors will be wary of lending to struggling Eurozone countries in fear of the contagion spreading and a further breakup of the Eurozone. This puts struggling economies like Spain, Portugal and Italy in a tough situation as the cost of borrowing rises to unsustainable levels, leaving them in need of a bailout. If such a thing were to happen, the Eurozone bailout fund may not have the capacity to bail out such large economies and they would in turn default on their debts.
However, this may not be the case if the Eurozone issues Eurobonds for all its member countries. This way the total amount of debt will be combined and investors would have greater security as the overall debt is more manageable. This being the case, bond yields would not rise and may instead fall which in turn will give the struggling Eurozone economies greater ability to pay not only their debt interest payments but also their outstanding national debt. In this scenario, a default may be avoided.
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Assess the advantages and disadvantages of a Eurozone breakup. (2017, Jan 11). Retrieved from https://graduateway.com/assess-the-advantages-and-disadvantages-of-a-eurozone-breakup/