Imagining the Unthinkable: The Disastrous Consequences of a Euro Crash

Part 2: Companies Envision Possible Scenarios

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It's also clear, says Hamburg economist Dirk Meyer, that the timetable for a euro exit in the affected countries would begin on a Monday, or "Day X." Over the weekend, the governments would have issued the surprising announcement that banks would remain closed on Monday. The bank holiday would be needed to include all savings and checking accounts in the operation.

On Tuesday, the banks and savings banks would begin stamping their customers' bank notes with forgery-proof ink. Capital transactions would be monitored. Black market prices would quickly develop in what the scenario defines as an "unofficial, virtual currency market." Another bank holiday would be needed to convert accounts and balances to the new currency. But at least another year would pass before new bank notes could be printed and distributed. The stamped euro banknotes would remain legal tender in the meantime.

But these are merely the technical consequences of a monetary reform. The economic consequences, which many German companies are now assessing, would be more serious. What happens if, in addition to Greece, other countries have to leave the euro zone? What will be the consequences if Spain, Portugal or Italy reintroduce their own currencies? Experts in the finance departments of some companies are already envisioning the possible scenarios.

For instance, they are examining whether the "euro" is explicitly defined as the agreement currency in contracts with customers from problem countries, so that they don't suddenly find themselves being paid in drachmas or escudos for their products. They are also looking into whether the costs incurred by a possible currency crash would be tax-deductible. And they are examining the potential need for write-offs if claims against business partners from southern countries are suddenly denominated in new currencies on their balance sheets. "The demand for consulting services has risen considerably in recent months," says Gunnar Schuster, an attorney with the law firm Freshfields Bruckhaus Deringer.

Germany Would Be Hard Hit

Germany, the great exporting nation, would be especially hard hit by monetary reforms in the southern countries. Exports to Italy and Spain alone are valued at about €100 billion a year. Although sales of cars, machinery, electronics and optical devices would not be eliminated altogether in the event of a euro collapse, there would be sharp declines, because customers in Southern Europe could no longer afford German products.

As soon as lira or pesetas were in circulation once again, the currencies would be devalued against the euro. Some expect their value to decline by 20 to 25 percent, while others believe that as much as 40 percent is likely. German goods would automatically become more expensive and would hardly be competitive anymore.

When BMW CEO Norbert Reithofer warns that a collapse of the euro "would be a catastrophe," and says that he "doesn't even want to imagine" the possible consequences, he isn't just thinking about declining exports. Reithofer fears that regionalism could return to Europe, and that countries could reintroduce customs barriers to protect domestic industry. And the current uniform environment protection rules would be replaced by a large number of national regulations. All of this would plunge the German export economy into a crisis.

The consequences would be extensive for companies that don't just sell products to Southern Europe, but also maintain branches there or hold partnerships in local companies. The German industrial conglomerate ThyssenKrupp, for example, earns about €1.6 billion in revenues in Spain, where it also employs 5,500 people, mostly in elevator production. Even more important to the company is Italy, where it makes €2.3 billion a year, mostly with the production of stainless steel.

ThyssenKrupp's business in Italy and Spain makes up 9 percent of total sales, which illustrates the importance of the two countries in terms of profits. If a reintroduced lira and peseta were devalued against the euro, the amount of money that the subsidiaries transferred to the parent company in the western German city of Essen would shrink.

A look at the statistics of Germany's central bank, the Bundesbank, illustrates the amounts of money at stake for the economy. They show that in 2010, German companies achieved sales of about €218 billion in Italy, Spain, Portugal, Greece, Ireland and Cyprus, with Italian subsidiaries alone accounting for €96 billion. The value of foreign direct investment in these countries is about €90 billion.

German companies would also benefit from a euro crash, because labor costs would decline in their Portuguese or Spanish factories, but on balance the consequences would be negative. After the last appreciation of the currency in Germany, when the deutsche mark was flying high in the mid-1990s, the export economy suffered the consequences for years.

Massive Shock for Banking Sector

The effects of a euro crash on the financial sector would be hardly less devastating. If Southern European countries left the euro zone, customers would raid their accounts in those countries, says Christopher Kaserer, an expert on capital markets at the Technical University of Munich. This could lead to "a bank run that Spanish and Italian banks would not survive." And because financial companies in these countries are closely intertwined with the rest of the euro zone, customers would also be lining up in front of German banks. "Without capital controls, this sort of a situation could spin out of control," says Michael Kemmer, head of the Association of German Banks. Economists anticipate that German banks would also have to be closed.

But even if there were no major bank run, the withdrawal of several countries from the euro zone would shake the European banking system to its very foundations, analysts with the major Swiss bank Credit Suisse have calculated in a study.

According to the study, if Ireland, Portugal, Spain and Italy joined Greece in leaving the euro, 29 large European banks would see a total capital shortfall of about €410 billion. "If the peripheral countries withdraw from the euro zone, a few of the large, publicly traded banks would come to a standstill," reads the analysts' sobering conclusion. In their predictions, the experts did not even take into account the likelihood that France would come under pressure if Italy withdrew from the euro.

Banks in the crisis-ridden countries would be especially hard-hit, but so would investment banks like Deutsche Bank. According to Credit Suisse, the market leader in Europe's largest economy, which prides itself in having survived the financial crisis without government assistance, would face such heavy loses that it would suffer a capital shortfall of €35 billion.

Whereas Greece is now almost irrelevant for Deutsche Bank, Italy and Spain account for a tenth of its European private and corporate banking business. The bank estimates the credit risks in these countries at about €18 billion (Italy) and €12 billion (Spain).

Large insurance companies are also active in Spain and Italy. Allianz, for example, holds Italian government bonds with a book value of €31 billion, which could create losses for the German insurance giant if Italy withdrew from the euro and had trouble paying its debts. Allianz also holds direct investments in banks in debt-ridden Southern European countries.

Companies, sensing the potential risks, are already doing as much as they can today to prepare for a European monetary storm. For instance, they are financing deals in the peripheral countries locally, so as to avoid currency risk. Investment bankers report that companies are receiving loans almost exclusively from banks in their own countries. Where cross-border transactions are unavoidable, banks are engaging in hedge transactions. IT systems are being prepared for a Europe with multiple currencies. And whenever they can, banks are establishing liquidity reserves or depositing money with the ECB.

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1. Politicians detached from popular sentiment?
derscheintrügt 06/25/2012
In Germany, mentions of Comma 4 of Paragraph 20 of the Basic Law (the german constitution) start to be surprisingly frequent. What is this comma about? Why, the right of the German people to depose their government by force if said government commits high treason by dismanteling the fundaments that "constitute" the german nation - and to cede budget control, reserved exclusively to the upper house of the german parliament, the Bundestag, to a supra-national (european) entity would do exactly that. It is probably not too far-fetched to imagine other european nations having similar clauses in their constitutions as well, although as long as one is on the receiving end of generosity it might probably be a little bit easier to close an eye or two...
2. Better Late Than Never
muley63 06/26/2012
Finally, an article that actually warns the Germans the economic abyss they face. Hopefully, it's not too late. Unfortunately, I wonder if the Chancellor refuses to listen to her advisers. In fact, I read that Guido the foreign minister is holding meetings about a federation and this, frankly, is unacceptable. First of all, Guido is a grasping, ineffective minister and second, how can a such a small group decide the fate of nations. After the Chancellor temporarily gets pass the crises, Merkel needs to seriously discuss with her political opponents about a European constitutional convention. Because if they think that they will create a new nation without going to the people, they are crazy. They need to get approval from all factions...not Guido and his merry working group.
3. The risks have been exaggerated
Eleos 06/26/2012
It seems to me that there is a fundamental flaw in the arguments presented: the Euro or Markel or whatever currency a nation uses is only a parameter. The wealth it measures is made up of the tangible and intangible assets that a country possesses, and those do not change overnight when the numbers denoting them are changed. There will be legal issues to be decided and there is the risk of cheating, but the essential wealth of each nation will not change on a dissolution of the Eurozone. Most want to follow the US and British examples of issuing sufficient money to convince the markets that it is futile to bet against printing presses on steroids, and so reduce the speculation. Let them have their way. The more fiscally prudent nations can leave and use a different currency. German exports depend on quality and efficiency not bargain basement price competition. The threats to stability seem urgent and important because markets have been allowed free rein. What is also needed is a substantial financial transaction tax, not large enough to dissuade those who have real business to conduct, just as we often pay a high price when we change currencies at an airport, but sufficient to stop the reckless speculation that seeks a miniscule advantage which can be massively leveraged.
4. Soon to Test This Theory
muley63 06/26/2012
---Quote (Originally by Eleos)--- ...Most want to follow the US and British examples of issuing sufficient money to convince the markets that it is futile to bet against printing presses on steroids, and so reduce the speculation. Let them have their way. The more fiscally prudent nations can leave and use a different currency. German exports depend on quality and efficiency not bargain basement price competition. .... ---End Quote--- German should go back to the gold standard if she doesn't feel the need to use modern monetary practice. Moreover, German have always had the reputation for quality. The phrase "German engineering" always meant the highest standard for 60 years. Yet, during the 90's, there was no export surplus. The only difference, IMO, is the introduction of the Euro which allowed German exporters to sell their good at a 20% discount and factor in the restructuring (lowering wages) between 2003-2010 and the result is the boom. All that will disappear because Germany is bent on destroying 40% of their market and the very advantageous currency they are using.
5. Blarney
tnt_ynot 06/28/2012
This article's fear mongering is irresponsible because of its exaggerations and omissions. The exaggerations foster fear mongering in example after example. There was life before the Euro and it worked well. Germany was then an export champion and will after the Eurozone members are re-structured. Turbulence will happen but it will be less of a disaster than Lehman and the past three years of crisis. More importantly is the article's omission of how disastrously costly a never-ending bailout of non-competitive economies will be. Anthony
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