It appears another rescue is on the way for Greece. It won't solve the currency union's problems. The real threat to the euro isn't that a weak peripheral country like Greece might withdraw in an effort to devalue its way to competitiveness, but rather that Germany might want to pull out.
Germany's incentive to leave grows with each bailout, and Berlin could ultimately make a simple calculation that extrication will be less costly than continuing the sacrifice needed to keep the euro.
Greece, Portugal, Ireland and Spain arrived at their positions via different paths, but they now at least partially share three problems that create challenges for others in the eurozone.
First, the combination of their outstanding debt and prospective deficits make markets fear that full repayment of their obligations is in doubt. This has led the official sector -- through the European Central Bank, the European Union and the International Monetary Fund -- to set up a funding mechanism that offers below-market financing in exchange for a promise from these nations that they will get their fiscal houses in order. (To be fair, Spain hasn't yet used the facility.)
Second, the growth outlook in each of the countries is grim, with high unemployment that is forecast to rise further. The remedies that are being proposed (to different degrees in the four countries) cut against longstanding social norms regarding social protections promised by the state. Given the diminished prospects for growth, the promises of increased tax revenue and reduced spending may not be achievable politically.
Third, all four countries would be much more competitive in the short-run if their exchange rates vis-à-vis their major European trading partners could depreciate substantially. Absent a move on the exchange rate, massive wage cuts and consistent productivity gains will be needed to make their products competitive. These more difficult reforms will eventually be necessary in any case, but there is no indication that the hard steps to achieve them can be sustained while the economies stagnate.
A depreciation that was engineered by leaving the euro would have prohibitive costs for the exiting countries, however. The banks in each of the countries would have obligations in euros that they wouldn't be able to meet. Plus, countries dropping the euro are required by treaty to also exit the European Union. In a worst-case scenario, the remaining euro countries could enact tariffs to counteract the competitive advantages of the depreciation and revoke rights associated with EU membership, such as the ability to work in a member state, for citizens of the exiting countries.
The combination of these challenges means the weak countries are in for a prolonged struggle to restore growth and meet their fiscal promises. It is hardly assured that their citizens will accept the tough reforms needed to succeed. If these efforts fail, the stronger countries, led by Germany, will have to provide funds to make good on the debt payments owed by the troubled ones, or allow defaults. But a default, especially by Spain, would imperil German and French banks that still have big exposures to these countries. Germany will choose a bailout again rather than let that happen.
And even with a substantial one-time reduction in debt for a country like Greece, trouble will reappear if competitiveness can't be restored, though Ireland might differ on this score. And there also is the risk that another rescue for Greece will weaken the commitment to promised reforms in other troubled nations. Why should the Spanish stick with a punishing set of adjustments when the Greeks have been spared? This raises the potential for a series of further bailouts, even as bailout fatigue in the countries providing the funds is already setting in. The German public, in particular, could reach a breaking point and decide their country shouldn't keep paying the bill for others.
At that point, there would be a temptation to strike a “grand bargain,” in which the Germans create a new currency that several other countries, such as the Netherlands, Austria and Finland, decide to join. These nations then announce that all obligations between their citizens will henceforth be denominated in the new currency, the Über Euro, which would eventually be managed by the Bundesbank. The Über Euro would initially be set at a value of perhaps 1.3 euros, setting the stage for an export boom for countries that continue to use the euro. This would allow the remaining eurozone members to restore their competitiveness without having their financial systems go bankrupt; it also would allow Germany to sell the plan as saving Europe without breaking up the EU.
The downside in this scenario is that banks in the German bloc would likely be bankrupt since some of their assets would still be euro-dominated and they probably wouldn't be able to pay off the domestic depositors and other domestic debt holders that would now be promised Über Euros. (Foreign depositors would be paid in euros). The silver lining is that this would force a definitive recapitalization of the German bloc's financial sector, which has been the real reason for the bailouts all along; and after the one-time exit fee, the Über Euro nations would no longer be obliged to keep bailing out their former partners.
Should the remaining euro countries continue irresponsible fiscal policies, the European Central Bank (which would continue to be their central bank), would slowly monetize their debt. The euro would continue to depreciate against the Über Euro and perhaps end up as junk currency.
There are practical challenges with this plan. It works best with immediate, unexpected implementation. The ECB's stature would be diminished and its balance sheet probably trashed. While unpleasant, it must be compared with other realistic alternatives for dealing credibly with the three chronic problems faced by Ireland, Greece, Portugal and Spain. There is no inherent reason the European project cannot proceed with two currencies and the citizenry may force this outcome.
(Anil Kashyap is a professor of economics and finance at the University of Chicago Booth School of Business and a contributor to Business Class. The opinions expressed are his own.)