Roubini: Debt Restructuring is Coming and so is the End of the Euro

Nouriel Roubini gets it. He writes in today's FT:

The muddle-through approach to the eurozone crisis has failed to resolve the fundamental problems of economic and competitiveness divergence within the union. If this continues the euro will move towards disorderly debt workouts, and eventually a break-up of the monetary union itself, as some of the weaker members crash out...

A reckless lack of discipline in countries such as Greece and Portugal was matched only by the build-up of asset bubbles in others like Spain and Ireland...

All successful monetary unions have eventually been associated with a political and fiscal union. But European moves toward political union have stalled, while moves towards fiscal union would require significant federal central revenues, and also the widespread issuance of euro bonds — where the taxes of German (and other core) taxpayers are not backstopping only their country’s debt but also the debt of the members of the periphery. Core taxpayers are unlikely to accept this...

Here the options are limited. The euro could fall sharply in value towards – say – parity with the US dollar, to restore competitiveness to the periphery; but a sharp fall of the euro is unlikely given the trade strength of Germany and the hawkish policies of the European Central Bank...

The German route — reforms to increase productivity growth and keep a lid on wage growth — will not work either. In the short run such reforms actually tend to reduce growth and it took more than a decade for Germany to restore its competitiveness, a horizon that is way too long for periphery economies that need growth soon.

Deflation is a third option, but this is also associated with persistent recession. Argentina tried this route, but after three years of an ever deepening slump it gave up, and decided to default and exit its currency board peg. Even if deflation was achieved, the balance sheet effect would increase the real burden of private and public debts. All the talk by the ECB and the European Union of an internal depreciation is thus faulty, while the necessary fiscal austerity still has – in the short run – a negative effect on growth.

So given these three options are unlikely, there is really only one other way to restore competitiveness and growth on the periphery: leave the euro, go back to national currencies and achieve a massive nominal and real depreciation...

Yet, scenarios that are treated as inconceivable today may not be so far-fetched five years from now, especially if some of the periphery economies stagnate. The eurozone was glued together by the convergence of low real interest rates sustaining growth, the hope that reforms could maintain convergence; and the prospect of eventual fiscal and political union. But now convergence is gone, reform is stalled, while fiscal and political union is a distant dream.

Debt restructuring will happen. The question is when (sooner or later) and how (orderly or disorderly). But even debt reduction will not be sufficient to restore competitiveness and growth. Yet if this cannot be achieved, the option of exiting the monetary union will become dominant: the benefits of staying in will be lower than the benefits of exiting, however bumpy or disorderly that exit may end up being.

Roubini is something of an optimist by thinking the euro has even five years. One point that Roubini does not focus on is that the fiscal undisciplined countries such as the PIIGS are likely, when resorting to their old currencies, to be aggressive money printers, thus moving from a bad situation to one that is even worse, possibly moving to hyperinflation.

That said it will remove the burden from relatively prudent governments such as Germany from supporting the reckless and that in the end is what will result in the eventual end of the euro.