Sunday, November 28, 2010

The Consequences Of A Breakup In The Eurozone

One aspect of the problems impacting a number of the Eurozone countries is the fact these issues were not addressed in the formation of the Euro. A recent article in the Telegraph notes, in 1990, Commission economists advised the EMU some of the issues facing the EMU today needed to be addressed before implementation of a single currency. According to the Telegraph,
"[the EMU] was told too that currency unions do not eliminate risk: they merely switch it from currency risk to default risk. For that reason it was all the more important to have a workable mechanism for sovereign defaults and bondholder haircuts in place from the beginning, with clear rules to establish the proper pricing of that risk. But no, the EU masters would hear none of it. There could be no defaults, and no preparations were made or even permitted for such an entirely predictable outcome..."
An article in the Financial Times, Investors Must Try To Predict German Politics (registration required), provides some thought on potential outcomes if there is a breakup of the Euro.
"A sovereign debt crisis will naturally affect equities. Banks hold their governments’ bonds on the assumption they are virtually risk-free. Any change to that assumption could drastically worsen their financial position. A devaluation to the currency would reduce the value of companies’ domestic earnings to foreign investors and make it harder for them to finance foreign debt.

But it is startling to see the extent of the pain that international stock markets think eurozone-based companies must endure. According to MSCI indices, developed world stocks outside the eurozone are up 7.22 per cent. European stocks outside the eurozone are up 4.45 per cent. And yet eurozone stocks themselves are down 9.82 per cent. Even within the eurozone, there is a stark division. Germany’s stocks are up a decent 4.4 per cent, according to MSCI. All the zone’s other big markets are down terribly. It is not surprising that Spain or Greece are down – but note that France has fallen 8.5 per cent and Italy 19 per cent. This implies extreme bearishness about the prospects for everyone in the eurozone, bar Germany."
In the Guardian, the Dutch bank Ing, opines that a breakup would be far worse than the issues dealt with in the bankruptcy of Lehman Brothers.
"In a bleak assessment, entitled "quantifying the unthinkable", they warn that in the first year alone, so by the start of 2012, output would fall between 5% and 9% across various member states, while their new national currencies would fall by 50%....

On the basis of a euro break-up by the end of 2010, he warned: "In 2011 a deep recession across the eurozone emerges, dragging down the global economy. In the eurozone output falls range from -4% in Germany to -9% in Greece".

But he notes neighbouring European economies are also caught up in the chill, with GDP falling 3% in the UK and 5% in central and eastern Europe.

"While the US would be less adversely affected, the combination of lower global growth and a strongly appreciating US dollar would see it flirting with outright recession in 2011," Cliffe added."
Lastly, in a paper commissioned by European Parliament's Committee on Economic and Monetary Affairs, a number of proposals are put forth to address the issues in the Eurozone. Much of what is addressed are guidelines that should have been put in place prior to the introduction of the Euro. I suppose better late than never. The document does address the consequences of removing members from the EMU: primarily the contagion that might follow.

At the end of the day it seems Germany is being asked to finance the profligate ways of some of the smaller European countries. Does Germany have the desire to keep the Eurozone together at the potential expense of its own financial stability? A number of difficult decisions need to be made by countries on both sides of these issues. These issues will be more difficult than determining a European standard for electrical plugs.

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