Why Germany needs to exit the Euro

The Euro perpetuates out-of-control fiscal policy that's making Europe weaker

The standard line in the EU these days is that countries - more than ever - need to stand together in the face of multiple threats. It’s actually the other way around. The thing many EU countries need above all else is fiscal space. Without that, there’s no cash to support Ukraine or ward off US tariffs and Chinese mercantilism. A German exit from the Euro will free up fiscal space for everyone. It’ll cause debt write-downs on the Euro periphery, bailing in households who’ve been unwilling to pay more taxes for the sake of debt reduction. It’ll free up cash in Germany and other fiscally frugal countries and allow them to focus on what’s important, which is the external threat from Russia and getting their own economies going again (as opposed to propping up unsustainable debt burdens on the periphery).

Russia’s invasion of Ukraine has shone a light on the lack of fiscal space. The chart above is from the Kiel Institute, which tracks financial, humanitarian and military aid commitments for Ukraine. The horizontal axis shows nominal 2021 GDP in € billions. The vertical axis shows support commitments for Ukraine - also in € billions - based on data through August 21, 2025. What’s striking is that neither Spain (ES) nor Italy (IT) are able to help Ukraine in ways that are remotely commensurate to the size of their economies. In fact, the three Baltic countries combined give Ukraine as much aid as each of Italy and Spain, even though their combined GDP is a fraction of either Italy or Spain. Russia’s invasion of Ukraine underscores a hard reality. Spain and Italy have run out of fiscal space. They deny this, but actions speak louder than words.

In yesterday’s post, I explained how the Euro has evolved into something that perpetuates this bad equilibrium instead of fixing it. The basic problem is that high-debt countries substantially outnumber low-debt ones, which means policy inexorably bends towards keeping unsustainable debt burdens going, including by co-opting the ECB into things like yield caps on government bonds.

It didn’t have to be this way. As the chart above shows, median net household wealth in Spain (blue line) and Italy (red line) far exceeds Germany (black line). That’s partly because home ownership in Italy and Spain is higher, but that doesn’t change the fact that this wealth can be taxed to bring down debt. When I suggest taxing this wealth, I’m invariably told that this is “unpopular,” but fiscal sustainability isn’t a popularity contest. It’s about having dry powder for when times get tough.

The Euro is really just a system of exchange rate pegs. Reverting to the national currencies of old doesn’t rule out common foreign policy, nor does it rule out joint defense spending. If anything, it makes those things easier, because debt write-downs in Italy and Spain will finally allow those countries to start spending again. The single biggest push-back to reverting to national currencies is that a breakup of the Euro would be turbulent. Actually, it doesn’t have to be. Like in a divorce, it’s in the best interest of all parties to separate peacefully and with a minimum amount of fuss. As part of such a divorce, the Euro periphery will no doubt demand financial support from Germany. That’s a price worth paying for Germany and is preferable to open-ended transfers, which is the status quo.

Periphery countries will never pull the plug on the Euro because they’re net beneficiaries (or at least their asset-rich elite are). So it’s up to Germany to pull the plug. That isn’t anti-European or anti-periphery. It’s just recognition of the fact that the Euro has evolved into something that Germans and other Northern Europeans don’t want. Better to pull the plug on that and emerge stronger, rather than stumble along in an equilibrium that makes everyone weaker.