Euro Crack-up Apocalypse

4 posts / 0 new
Last post
machinehead's picture
machinehead
Status: Diamond Member (Offline)
Joined: Mar 18 2008
Posts: 1077
Euro Crack-up Apocalypse

Ambrose Evans-Pritchard summarizes a report by ING bank titled 'Quantifying the Unthinkable,' dramatizing what would happen if the euro monetary area broke up. 'Bigger than Lehman,' they warn, in a style that reminds me of the late Paul Erdman's fictionalized visions of dollar-collapse doom:

"Complete break-up would have effects that dwarf the post Lehman Brothers collapse. Governments would find themselves having to bail out banks again, worsening already fragile government finances. The risk of at least a temporary break-down in payments systems would be enormous, " said the report by Mark Cliffe, Maarten Leen, and Peter Vanden Houte.

"Initial trauma is sufficiently grave to give pause for thought to those who blithely propose EMU exit as a policy option," it said, a rebuke to those German politicians and economists who have talked openly of shaking out weaker members.

The new Greek drachma would crash by 80pc against the new Deutschemark. The currencies of Spain, Portugal, and Ireland would fall by 50pc or more, causing inflation to soar into double-digits. "The impact is dramatic and traumatic," it said.

"In the first year, output falls by between 5pc and 9pc across the various former member states," it said.

The German sphere would face a "deflationary shock". The US dollar would rocket to 85 cents against the euro equivalent, with a "temporary overshoot" to near 75 cents. This would tip the US into acute deflation, threatening North America with a double-dip recession. East Europe would contract 5pc in 2011 alone.

Safe-haven flows to core debt markets would drive down yields on 10-year US, German, and Dutch bonds to near 0.5pc, by far the lowest ever. Club Med yields would decouple brutally, rising to between 7pc and 12pc, "capital controls, notwithstanding."

The UK economy would shrink by 4.5pc from 2011-2012. Safe-haven flows pouring into Britain would drive sterling through the roof. Eurozone demand for UK exports would contract viciously. Pension funds would suffer fat losses on eurozone assets. UK lenders would face havoc again though a web of cross-border linkages.

This is the picture of a world falling apart. 

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7877724/EMU-break-up-risks-global-deflation-shock-that-would-dwarf-Lehman-collapse-warns-ING.html

Soon to be released as a major motion picture, one presumes. Let's hope the director eschews morbid zombie and vampire themes, although that's exactly what came to mind at the Deutschmark's funeral:

However, there's an alternative scenario not considered in the ING Bank report. In some ways, it's even scarier, because the 'first mover' -- the one who sacrifices conventional respectability and bails first -- wins the most:

 If Greece devalues and defaults as well, the calculus is different. Many big bust-ups entail both, such as the Argentine crisis in 2001. Some Argentines argue that their trauma proved cathartic, pulling the country out of a destructive downward spiral.

If Greek, Portuguese or Spanish leaders ever start to ask their own Argentine questions as austerity grinds on, and unemployment grinds higher, events will run their ineluctable political course regardless of the greater risks.

This is no theoretical speculation. In This Time Is Different, authors Rogoff and Reinhart point out that only a handful of countries have ever 'grown their way out' of a debt crisis. Most ended up restructuring, a euphemism for default in the form of principal haircuts, reduced interest rates, and extended payment terms. 

I say that partial default is the certain endpoint of Greece's plight. It's only a question of timing. Euro, we hardly knew ye.

 

pinecarr's picture
pinecarr
Status: Diamond Member (Offline)
Joined: Apr 13 2008
Posts: 2244
Re: Euro Crack-up Apocalypse

Interesting, machinehead!  I find myself both anxious and fascinated by all that is going on, at the same time!

machinehead's picture
machinehead
Status: Diamond Member (Offline)
Joined: Mar 18 2008
Posts: 1077
Re: Euro Crack-up Apocalypse

Right on cue, George Soros weighs in with his own version of a euro crack-up scenario:

Let us consider where [Germany leaving the euro] would lead.

The Deutschmark would go through the roof and the euro would fall through the floor. This would indeed help the adjustment process of the other countries but Germany would find out how painful it can be to have an overvalued currency. Its trade balance would turn negative and there would be widespread unemployment. German banks would suffer severe exchange rate losses and require large injections of public funds. But the government would find it politically more acceptable to rescue German banks than Greece or Spain. And there would be other compensations: pensioners could retire to Spain and live like kings, helping Spanish real estate to recover.

Let me emphasize that this scenario is totally hypothetical because it is extremely unlikely that Germany would be allowed to leave the euro and to do so in a friendly manner. Germany’s exit would be destabilizing financially, economically, and above all politically. The collapse of the single market would be difficult to avoid.

http://www.nybooks.com/articles/archives/2010/aug/19/crisis-euro/?pagination=false

Actually this doesn't sound so bad to me, except for the 'collapse of the single market' bit, which would be regrettable. Many Germans (hell, americanos too!) fondly remember the dirt-cheap, tourist-friendly Spanish peseta.

machinehead's picture
machinehead
Status: Diamond Member (Offline)
Joined: Mar 18 2008
Posts: 1077
Re: Euro Crack-up Apocalypse

Okay, let's let Roger Bootle take a crack at a euro bust-up scenario. This is my favorite so far:

As an economy moves into deflation, the real rate of interest rises. As Greece deflates, there will be no reduction of Greek bond yields commensurate with the prospective diminution of the Greek tax base. So there is an acute tension between trying to solve the debt problem and trying to solve the competitiveness problem [with Germany].

Under the current set-up, the euro-zone confronts an uncomfortable choice:

(i) Higher rates of inflation in Germany and the rest of the northern core, which would make it easier for Club Med to achieve lower rates of inflation than the core

(ii) Default by some or all of Club Med

(iii) Some, or all, of the Club Med members leave the eurozone;

(iv) Germany, accompanied probably by Austria, Benelux, Finland and possibly France, leave

My guess is that if the first option is not allowed then either options two and three will happen together or Germany will forestall them by leaving the euro first.

http://www.telegraph.co.uk/finance/comment/rogerbootle/7884240/PIIGS-may-yet-fly-but-not-while-theyre-trapped-in-this-rickety-eurozone.html

Roger that! Since the ECB will veto option (i), basically it's a horse race between (ii) + (iii) and (iv). Say 70% probability of (ii) + (iii) happening first; 30% probability of (iv) being the trigger. Meanwhile the entire official sector (G8, EC, IMF, BIS, ECB, etc.) are in DENIAL! The longer they wait, the bigger the restructurings will be.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Login or Register to post comments