What are the Consequences of a Eurozone Break-up?
DK Matai
baffling expedients, of delays, is coming to its close. In its place
we are entering a period of consequences." That was Churchill in a
speech to the House of Commons at the Palace of Westminster in London
on November 12, 1936, as clouds darkened over Europe, three years
before the outbreak of the Second World War. Dark clouds are now
hovering once again over Europe in regard to the single currency,
eurozone sovereign defaults and an interlinked banking crisis. This
is not going to take three years.
Complex Consequences
If the eurozone breaks-up, it is likely to have enormous consequences
for world markets and the global economy. It will also mark the end
of the European "political" Union as we know it. The eurozone has
been lurching from one debt crisis to another. Many distinguished ATCA
5000 members are now asking, "Can the single currency survive in its
present form, and if not, what are the consequences?" There are a
variety of compounding challenges to add to this chaos:
1. The huge exposure of the eurozone banking system to sovereign
debt;
2. The credibility of the secretive European Central Bank (ECB); and
3. The fear that self-imposed austerity measures are likely to
smother any chance of economic recovery in Europe.
Threat to the Status Quo
Under the current structure and with the current membership, the euro
is clearly not working. The problem facing the euro now is to
convince the world that it is more than an act of political levitation
underpinned by a series of inconsequential summits that announce a
plethora of smoke-and-mirror policies. Although the official line has
been for month to say that the euro will somehow pull through, rising
bond market volatility suggests that it most probably will not. This
is not merely a question of putting trillions of euros together to
bail out weaker member nations, but creating an organisational
structure that will give the currency robustness and resilience which
it appears to lack at a fundamental level at present. The euro
creates more economic costs than benefits for at least some of its
members -- a fact that has become painfully obvious to some of its
participants in recent years. Either the current structure will have
to change, or the current membership will change. The Eurozone status-
quo cannot remain intact.
Exit Scenarios
If a weaker country such as one of the PIIGS -- Portugal, Ireland,
Italy, Greece or Spain -- leaves the euro, the consequences include:
1. Sovereign default;
2. Corporate default;
3. Collapse of the banking system, at least in part;
4. Collapse of international trade and interruptions of supply
chains; and
5. Devaluation of a new currency, which may offer limited assistance
in the short term as import costs cause inflation.
Italy and Spain rank 3rd and 4th within the Eurozone in terms of
population, GDP and contribution to the EU budget. Together, Italy and
Spain make up about a quarter of the EU contributions and together
they are bigger than Germany and substantially bigger than France.
That suggests just how grave the situation really is, especially from
Germany’s perspective, and why the Germans know that they can’t save
themselves as well as Italy and Spain simultaneously.
If a stronger country such as Germany or France leaves the euro, the
consequences include:
1. Corporate default;
2. Recapitalisation of the banking system;
3. Collapse of international trade and interruptions of supply
chains; and
4. Appreciation of a new currency, which may offer limited assistance
in the short term as export prices rise and economic activity begins
to stall.
Banking System Contagion
The banking system is likely to be the most immediate transmission
mechanism for carrying the crisis beyond the borders of the nation
state seeking exit. If bank runs and enforced conversions in the
exiting state are witnessed elsewhere in the Eurozone, citizens of any
euro member state that is considered to be a possible candidate for
secession would start to liquidate across all asset classes and
withdraw their bank deposits from their domestic banking system out of
fear and panic. This is already happening in the case of Greece and
beginning to happen in the cases of Italy and Spain. Bank runs could
spread well before the actual act of secession can takes place.
Therefore, the bank runs could become a catalyst for a more widespread
financial crisis in the Eurozone system as well as the global
financial sector. This could be mitigated by the intervention of the
local central banks to a small extent as far as their domestic needs
are concerned. On a trans-national basis large capital flows are
likely to carry the contagion to many financial centres around the
world. This also means that non-Eurozone financial institutions --
particularly US ones -- would come under pressure due to their
exposure to bank financing with European banks through money markets
and repurchase agreements.
Resilience and Robustness
It seems highly unlikely that a government could leave the euro and
expect to remain a fully functioning member of the European Union
itself. The act of leaving the euro necessitates a unilateral breach
of the Treaty of Maastricht, the Treaty of Lisbon and by extension the
Treaty of Rome. Yet we find in those treaties themselves, and in the
rhetoric which surrounded them, the primary delusions behind the
creation of the single European currency:
1. The belief that political vision can defy markets;
2. The belief that a unified currency could underpin Europe’s place
in the world, politically and economically; and
3. The belief that such a currency should be the most significant
physical manifestation of Europe’s desire for unification.
It is clear that these widely mooted viewpoints have bestowed some
mystical powers upon the euro, allowing it to exist. In reality, it
neither has mystical powers nor the divine right to exist. The euro
architects managed to convince the world for 12 years that its major
flaws were minor inconveniences. If its least significant member,
Greece, can tip it into a full-blown crisis after only these few
years, where is the resilience and robustness in its system
architecture?
Hedging and Financial Markets
For institutional as well as private investors, the only way to hedge
against a euro break-up scenario would be to minimise the ownership of
paper assets denominated in euros. The impact of the Eurozone break-
up will be to cause the global financial markets to become extremely
volatile and dysfunctional. This in turn may cause the quadrillion
dollar derivatives pyramid to crumble, generating massive counter-
party losses and systemic risk amongst financial institutions.
Soft Power
Fragmentation of the euro would incur political costs as well. The
European "political" Union would cease to exist in the way we have
come to know it. Europe’s “soft power” influence internationally
would fade as the concept of “Europe” as an integrated political
entity would be rendered meaningless.
Social, Economic and Political Chaos
It is certainly worth noting that several countries in the euro area
have histories of internal political division -- Belgium, Italy and
Spain being amongst the most obvious examples. Those divisions are
likely to be exacerbated as a result of a break-up of the Eurozone.
This could contribute to greater social unrest in those countries. It
is also true that monetary union break-ups in history are nearly
always accompanied by extremes of civil disorder, civil war or
anarchy. We have already seen the beginnings of civil disturbances
like the opposition to the IMF-EU-ECB rescue packages manifest in
countries such as Greece, Ireland and Portugal, as well as new
rumblings in Italy and Spain. To quote Lord Keynes “Lenin was
certainly right. There is no subtler, no surer means of overturning
the existing basis of society than to debauch the currency.”
Almost no modern monetary unions, built around fiat currencies, have
broken up without the rise of some form of authoritarian or military
government, not to mention the breakout of civil war or its equivalent
along the way. If a country has gone to the extreme of reversing the
introduction of the euro, it is at least plausible that fracturing
forces may re-emerge to break apart key political and other structures
of its society. At the very least, escalating social unrest seems
inevitable.
New Equilibrium
Romano Prodi, the then EU Commission President, said in December 2001,
“I am sure the euro will oblige us to introduce a new set of economic
policy instruments. It is politically impossible to propose that now.
But some day there will be a crisis and new instruments will be
created.” The process of disintegration of the financial and banking
system in Europe, even if only in part, is now a highly probable
outcome resulting from cascading events underway. On the other hand,
in the Hegelian tradition of how change happens, transformation is
bound to take place in the way that Europe manages itself. The
specific steps on the path to disintegration or its lesser cousins
cannot be fully anticipated at this juncture and in the end they are
likely to be a source of surprise for us all.
Conclusion
It is becoming increasingly obvious that the Eurozone is going to
experience the exit of one of its member countries in the very near
future. The cascading consequences pose existential challenges for
the Eurozone and the European Union.
Given the nature of the interlinked global financial markets, the rest
of the world including the United States and China will not remain
unscathed. China has placed significant faith in the Eurozone in
recent years -- as the European Union has become its number one export
market -- to park its excess reserves and it may have to reassess its
strategy of portfolio diversification away from the US as the Eurozone
crumbles.
Let us not underestimate the gravity of the crisis we are going
through, and its potential outcomes. However, we should also consider
the possibility that in the midst of crisis political leaders may
respond by radically revising their hitherto entrenched positions. It
remains plausible that out of this historic crisis a more sober and
realistic political ethos in the region may yet emerge, one that could
eventually lead to a renaissance towards a more sustainable Europe in
the years ahead. The scale of the crisis, viewed through the prism of
history, could yet generate opportunities to lead Europe forwards in a
fundamentally different way.
[STOPS]
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[ENDS]
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All the best
DK Matai
Chairman and Founder: mi2g.net, ATCA, The Philanthropia, HQR, @G140
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Richard
this "In reality, it neither has mystical powers nor the divine right
to exist" I was thinking about The Mandate of Heaven. Just thought I
would pop in.
R
> PIN -- by going tohttps://www.yammer.com/atca[Note: In https:// 's'
> is for security and encryption]
>
> iii. If you don't have membership of the PIN yet, email the mi2g
> Intelligence Unit at intelligence.u...@mi2g.com for an exclusive
> invitation.
>
> Q2: How to participate in the expert roundtables and get domain-
> specific strategic intelligence questions answered?
>
> A2: Access the ATCA 24/7 Private Intelligence Network -- PIN -- online
> and ask or answer a strategic intelligence question, no matter how
> complex. Receive expert answers within 24 hours or get pointers from:
>
> i. ATCA 5000 experts who are online;
> ii. ATCA Research and Analysis Wing; and
> iii. mi2g Intelligence Unit.
>
> Q3: Why is the ATCA 24/7 Q&A Exclusive Club special?
>
> A3: ATCA 24/7 has now created an exclusive private intelligence
> watering hole and expert roundtable at the highest level where
> interesting and sophisticated questions are being asked from around
> the world, and intelligent answers are being provided, almost always
> by experts who have deep domain-specific knowledge. Come and check out
> the exclusive club, take it for a strategic test drive, which sign-of-
> intelligent life are you waiting for?
>
> To learn more about "The Expert Roundtable: ATCA 24/7 Q&A Club" email:
> intelligence.u...@mi2g.com and if you are already a member visithttps://www.yammer.com/atca