Cutting Off Euro-Nose to Spite Face

Enough of the levity (see previous). It’s time to get serious – even “apocalyptic.” Specifically, The apocalyptic cost of the collapse of the Eurozone, a recent entry on the blog of Libération’s famed Brussels correspondent, Jean Quatremer.

That article basically calls attention to a recent, publicly-available and English-language study from ING Bank (main writer: Mark Cliffe) entitled “EMU Break-up: Quantifying the Unthinkable.” It’s quite an eye-opener, and Quatremer has performed quite a public service in calling his readers’ attention to it. For the “unthinkable” when it comes to the euro has become quite a bit less so this year, including the two “unthinkable” extremes between which Cliffe structures his report’s analysis: 1) The departure from the Eurozone of Greece (only), and 2) The collapse of the whole thing, with the current member countries simply reverting to their currencies of prior to 1999. Both developments, and various others in-between, have increasingly been raised as distinct real-world possibilities, and not just as horror-scenarios but also as measures to be induced deliberately (particularly the ejection of Greece) as punishment for the fiscal failings of various naughty governments.

The point of the report, though, as Cliffe continuously emphasizes, is not to evaluate the likelihood of either of these two boundary-situations actually happening, but rather to assess the economic and financial consequences if they do. It should make sobering reading for anyone with actual European financial policy responsibility. According to the ING analysis, a Eurozone collapse would have “dramatic and traumatic” effects on the whole world economy, far surpassing the explosive impact of the Lehman Brothers bankruptcy of September, 2008, even under the assumption that it would take place under as pre-planned and controlled conditions as possible. Perhaps the best place to look to grasp the impact is the resulting valuations between the old Eurocurrencies which would become “new” again as the Eurozone countries revert to them: Cliffe forecasts Spain, Portugal and Ireland devaluing by 50% against the new Deutschmark, and Greece a full 80%. (“Core” Eurozone countries like Austria and the Benelux would devalue by about 7.5%.) Either these countries’ external debts would multiply by the inverse of these devaluations (e.g. Greece by a factor of 5) if they decided to keep the foreign-currency value of their debts constant – unlikely – or the holders of such debt would suffer the corresponding loss in value. This would then make interest rates – and inflation – in the devaluing countries explode, with the opposite effect (even leading to deflation) in Germany and possibly the other core countries. Meanwhile, the banks in those core countries, having made those loans and suffered such losses, would need to be bailed out by their governments once again. Even the US, whose dollar would skyrocket in value against all the new/old Euro currencies (new aggregate value of around €0.85 to the dollar), would suffer a severe deflationary shock as imports from Europe became so much cheaper and domestic demand thereby took a serious hit.

Overall, Cliffe expects the immediate impact of such a collapse of the Eurozone to be yearly GDP losses for all European countries of between 5% and 9%, lasting for a couple of years at least. The “Greece leaves the Eurozone” scenario is of course rather less severe than that, but still bad: Greece suffers a drop in GDP of 7.5% while other European countries still see their output fall by up to 1% due to a feared “domino effect” extending to other weaker countries on the Euro-periphery and the general chilling effect of such a loss of confidence on trade.

But Don’t Underestimate Our Will!

Somewhat by way of antidote, Quatremer also links to another bank analysis, this one from the French bank Natixis (written in French) by Patrick Artus. His main point: Everyone (especially the “Anglo-Saxon” analysts from New York and London) may be telling you that the financial data point inevitably to the departure of one or more of the “peripheral” countries from the euro and a resulting risk that the whole Eurozone could collapse. But don’t believe them: above all, the euro is a political phenomenon, and these analysts are underestimating the sheer political will within the EU to make sure that none of this happens, as demonstrated by the huge sums of money committed to a Euro Stabilization Fund plus the new willingness of the European Central Bank to purchase public debt, including that coming from Greece.

Actually, going through M. Artus’ Natixis report, one is rather struck by, if anything, his series of graphs which serve precisely to illustrate those “Anglo-Saxon” arguments about how defaults and Eurozone exits would appear to be inevitable! We’d all better hope that he turns out to be correct with the argument his paper is actually trying to make! As for that ING report, its scariest aspect is how the deliberate ejection of certain countries from the euro (Greece at the head of the line) and even the currency’s break-up (usually not completely, but into various sub-groupings) have actually been advanced on occasion as legitimate policy alternatives. That report needs to gain a wide circulation among EU policy makers, to convince them just how disastrous and self-defeating any such measures would turn out to be.

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