What if … Spain leaves the Euro!

Written on August 6, 2012 by Dirk Hopfl in IE News

IE Focus | By Patricia Gabaldón, Professor at IE Business School

The hypothetical decision to bring back the peseta would not address the real problems currently dragging Spain down, namely its level of competitiveness. All it would do is put off the inevitable, and meantime we have a lot to lose.

As with any kind of decision we have to make in our lives, before embarking on a definitive path we have to consider the pros and cons of the different options and compare the costs and benefits of an alternative economic environment. The option of leaving the euro and returning to our respective currencies, which seemed all but impossible just a few months ago, is now quite feasible. Many alternatives have been broached in economic circles, but let’s take another look at what the single currency actually gives us, and what it would mean for Spain if it were to leave the monetary union.

The main advantage of forming part of a monetary union is the resulting free trade among member countries. The simple idea of sharing the same currency reduces the level of uncertainty surrounding transactions by removing transaction costs for traders. The fundamental premise of the free movement of goods, services, people and capital (although in reality it has not proved quite as efficient as it looked on paper) plays a key role in economic growth driven by trade. The idea of unemployment offset by the need for workers in another part of the EU is difficult to implement but not impossible, and provides an enormous advantage for EU citizens as well as member countries.

The second big advantage of belonging to the Union is clearly the monetary stability it has provided over the last twenty years, because we should not forget that during this time we have enjoyed particularly low rates of interest and inflation under the management of the European Central Bank, which would have been very difficult to achieve with any other travel companions. This has had some very positive effects on Spain, particularly the rise in business investment and the entry of foreign capital investment. Moreover, the principle of EU solidarity has meant that the transfer of funds – structural, social, agricultural, etc., has strengthened social and economic structures and raised Spaniards’ standard of living. All this plus the growth of the Spanish economy on a global scale. Since Spain joined the EEC in 1986, its economy has been modernized and the number of workers and businesses have increased, along with living standards. The downside is that along the way we have lost control of our monetary policy along with the ability to use the exchange rate as a economic policy tool, and our fiscal policies have been subject to spending limits, which may have hindered our growth rate in the years leading up to the crisis.

The return to the peseta would afford greater flexibility to implement competitive devaluations that would adjust currency values to the real situation of our economy. Devaluation would make us more competitive vis-a-vis other countries, placing us in a more advantageous position to effect a probable increase in productivity and bring down unemployment levels. Nevertheless, having our own currency would almost certainly have a negative effect on Spanish trade, given that it would impose the uncertainty of exchange rate fluctuations on cross-border transactions, coupled with a return of all the costs associated with trading in a different currency. If we take this same line of analysis further, we can also see that an increase in country risk would probably result in higher rates of interest, which would have a negative effect both on investors and anyone who has debts that are subject to variable rates of interest. And the fact that Spain would no longer be subject to the strict inflation controls imposed by the ECB would mean that possible external pressures on the currency would more than likely increase the rate of inflation. All this without taking into account a possible flight of capital out of Spain resulting from a lack of confidence in the new currency, or in the process that led to it.

And yet even if this currency control were effective and efficient, it would merely mask the solution to the real problem. The possibility of competitive devaluation is interesting in such an uncertain environment and amid sporadic attacks on the currency of a country, but in our case rather than solving the very real problems of competitiveness, it would simply defer them. The euro has given us much and has brought about deep-rooted change in Spain, but there are still many flanks that need attacking, and although this may not be the environment in which to do it, we cannot just close our eyes and pretend that the problems do not exist. The solution, as has been stated repeatedly in recent times, is more Europe not less. It’s time to look toward the objective, not go back to square one.


Lalitha Seelam August 14, 2012 - 3:06 pm

Great blog that gives a comprehensive view of Spain’s economy, if it embraces Peseta! I somehow feel that structural changes and supply policies are the need of the hour which may help Spain and other countries to come out of this crisis. Wondering how a fiscal union which may have more control on the budgets of EU nations will help to abate this whole crisis scenario! Really surprised how markets are reacting to the Trioka’s decisions each day with fluctuations in yield rates thus affecting the sovereign ratings of EU nations and finally the global economy!

Gonzalo Melián August 15, 2012 - 5:17 pm

Dear Patricia,

According to your post “Devaluation would make us more competitive vis-a-vis other countries, placing us in a more advantageous position to effect a probable increase in productivity and bring down unemployment levels”. On the other hand the problems that can arise if Spain returns to the peseta are “all the costs associated with trading in a different currency”, “higher rates of interest, which would have a negative effect both on investors and anyone who has debts”, “increase the rate of inflation” and “a possible flight of capital out of Spain” according to your post too. I think that you did not mention other two important problems associated with the return of the peseta and in my opinion are important to consider the pros and cons of our decision as you said.

Fistly, Spaniards are going to be poorer due to the devaluation of our currency. As Juan de Mariana said in his treatise on currency La Moneda de Vellón, when we devaluate the value of our currency we create inflation and it is as we pay more taxes and we are poorer. People who live and get their main salary in Spain are not going to be able to go out from Spain for business or tourist. Furthermore, they will not be able to buy many things in Spain because we have an important amount of goods, which come from out of Spain. This situation could happen as you explained due the possible external pressures on our currency but we cannot forget our history. Our inflation is going to be worse due to the irresponsible politicians who are going to devaluate even more our money and our wealth is going to decrease dramatically.

Secondly, it is true that we are probably going to have higher rates of interest. So people who have debts are going to have several problems to pay them. But the main problem is not only the private debt but also our public debt. We are not going to be able to pay our public debt. It is like to say to the markets that Spain as a country is not trustworthy. Nobody is going to lend money to Spain.

With only these two problems the economic environment of Spain is going to be worse than today. Today it is not the best, but if we want to get a better economic environment to bring down unemployment levels in Spain we need to solve our structural problems as our high level of corruption, our labour market, our government spending, our investment freedom, our financial freedom, our business freedom, our high level of taxes among others before to bring back the peseta. Of course we have other important problems as our bank system but our politician are playing in my opinion in the wrong way doing a ball-out. If we want to solve this problem we need to star to think in ball-in (http://online.wsj.com/article/SB10001424052702303822204577464601755598634.html).

I can be wrong but in my opinion if we solve these problems (before returning to the peseta), we are going to be in a better position than Botswana at the Index of Economic Freedom done by Heritage Foundation (http://www.heritage.org/index/default) and we are going to have a better economic environment to decrease our unemployment levels.

On the other hand, if more Euro means more regulations and less freedom I don’t want to be there.

All the best,
Gonzalo Melián

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