On the Two Major Risks with the Euro: Sovereign Default and Redenomination or Intra-Euro Currency Risk

Currently there remains a strong strand of belief (particularly in euro zone countries) that exit is impossible. As we have already seen in 2010–12, markets are constantly probing and re-evaluating the probabilities and scale of alternative outcomes, and managing their investment and derivative positions accordingly. To date, most of the market pricing of euro stress has been concentrated in the sovereign debt markets. But this represents just one of two risks within the euro — the risk of sovereign default. The other risk — the risk of redenomination (or ‘intra-euro currency risk’) — has so far found little direct expression in the markets.

With a euro exit, this belief would be shattered and, once that happened, almost all of the advantages that a single currency had over an exchange rate mechanism would evaporate. It is likely, if there are any exits from the euro zone, that markets will begin to discriminate in favour of ‘strong’ (predominantly northern) debtors and against weak (predominantly southern) debtors on the basis of perceived exit risk. This could lead to a rapid emasculation of southern countries’ banking systems as southern depositors moved their deposits north for little or no cost or loss of interest.

—Neil Record, “Managing the Transition: A Practical Exit Strategy,” in The Euro: The Beginning, the Middle . . . and the End? ed. Philip Booth (London: Institute of Economic Affairs, 2013), 148-149.