When the Euro Falls Apart

This paper recounts some well‐known problems confronting European monetary union (EMU), such as withstanding asymmetric shocks and maintaining domestic political support. It then examines how a speculative attack could damage a target country's banking system, and how the basic structure of EMU could facilitate its break‐up. On the basis of this analysis, one might reasonably conclude that there is a significant chance – over one in ten – that EMU may break up in whole or in part. The paper then focuses primarily on two significant problems related to a break‐up. First, a country seeking to leave EMU, particularly after the transition period, may have difficulty re‐establishing its national currency unilaterally, as its economy is likely to have become thoroughly ‘euroized’. Second, any break‐up accompanied by re‐denomination of existing euro obligations, including government bonds, will create great legal uncertainty and costly litigation. There are no continuity of contract rules for exiting EMU equivalent to those for entering. Both problems require cooperative and deliberative solutions and will be difficult and costly to solve. If such problems are properly taken into account, which has not previously been the case, a euro break‐up in the foreseeable future, particularly after transition, is considerably less likely than the above estimate of one in ten.