Ireland and the Eurozone

Mohamed El-Erian says that instead of being bailed out, Ireland should default on its debts and devalue its currency:

In a wider policy debate, debt restructuring would be considered as a possible pre-emptive option rather than a disorderly inevitability; thought would be given to the possibility of the weakest Euro-zone members taking a type of sabbatical from the club and rejoining on a stronger and more sustainable basis.

That sounds great — though whether Irish leaders think it sounds great is another thing entirely. What’s more, it seems to me that this has been considered before. Here is Felix Salmon’s take:

Right now […] it’s possible to structure a default and devaluation in such a way that the country concerned emerges in a strong fiscal position and with a healthy growth outlook. But the longer we wait, the harder that becomes.

I do think that it would be grossly unfair should the lenders to Ireland’s insolvent banks find themselves getting bailed out by Irish and EU taxpayers at 100 cents on the dollar. Is a sovereign debt restructuring the only way to avoid that? I’m not sure. And it’s also politically all but impossible to build a mechanism into the eurozone allowing countries to exit and re-enter again at a more competitive level, now that the currency union has been deliberately designed without that possibility in place.

Well, I’m confused. A debt default is certainly possible — default is always possible — but exiting and re-entering the eurozone is more than just politically difficult, isn’t it? Once something like that happens, there just isn’t a eurozone anymore. No one will believe it. If Ireland leaves (and I’m not even sure how that would work technically), it needs to be gone for good.

And who knows? If there’s a way to pull that off, maybe that’s what will happen. But that’s always been the core of the problem. Countries have defaulted on debt lots of times, and often it works out just fine. But it has to be accompanied by devaluation, and that can’t happen in a country that’s part of a wider currency union and has no control over its exchange rate. Or am I missing something here?

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