Imagining the Unthinkable The Disastrous Consequences of a Euro Crash
Part 3: 'Consequences of Disaster Would Spread Like a Tidal Wave'
In the real economy, companies are also doing what they can to prepare for a worst-case scenario. If possible, they are only doing business in the crisis-ridden countries that they can finance locally. Investments in Southern Europe are being scaled back, and instead companies are trying "to accelerate growth outside the euro zone, such as in the emerging economies of Asia and Latin America," says one investment banker. This explains why mergers and acquisitions have virtually ground to a halt in Europe.
It's understandable that companies want to protect themselves from a euro crash. But if things get serious, all of these efforts could be worthless, because the consequences of a monetary disaster would spread across the entire economy like a tidal wave.
Economists with the Dutch bank ING have calculated that in the first two years following a collapse, the countries in the euro zone would lose 12 percent of their economic output. This corresponds to the loss of more than 1 trillion. It would make the recession that followed the bankruptcy of investment bank Lehmann Brothers seem like a minor industrial accident by comparison. Even after five years, say the ING experts, economic output in the euro zone would still be significantly lower than normal.
The consequences would also be catastrophic in Germany, as the German Finance Ministry concluded in a study commissioned by Finance Minister Wolfgang Schäuble, a member of the center-right Christian Democratic Union (CDU). The recovery and economic miracle would abruptly come to an end, and instead banks and companies would start collapsing like dominoes, after having to write off receivables and investments.
The German Finance Ministry's prognosis is even grimmer than that of the ING experts. According to their scenarios, in the first year following a euro collapse, the German economy would shrink by up to 10 percent and the ranks of the unemployed would swell to more than 5 million people. The officials were so horrified by their conclusions that they kept all of their analyses confidential, for fear that the costs of rescuing the euro could spin out of control. "Compared to such scenarios, a rescue, no matter how expensive it is, seems to be the lesser evil," says one Finance Ministry official.
Costs of Crash for Germany Could Be More than 500 Billion
The dream of balanced budgets would be dead for years. Government debt would rise sharply as tax revenues declined and government spending, on everything from bank bailouts to unemployment insurance, increased. Hundreds of thousands of jobs could be outsourced to other countries, and thousands of companies could go under.
According to a scenario by the major Swiss bank UBS, if the financial risks resulting from the decline in exports, the necessary bank bailouts and the company bankruptcies are added together, the total cost to the German economy could amount to a quarter of Germany's gross domestic product -- well over 500 billion.
And this doesn't even reflect the biggest financial risk, which remains hidden. In the last two years, the ECB has bought up more than 200 billion in sovereign debt from crisis-ridden countries. It would have to write off some of that debt in the event of a euro crash, which would also spell losses for the ECB's largest shareholder, Germany's Bundesbank central bank.
The so-called Target2 balances pose another threat. Through this internal payment system in the euro zone, the Bundesbank has accumulated about 700 billion in claims against the central banks of countries like Greece, Spain and Italy. This is more than five times the Bundesbank's own capital.
"If the monetary union collapsed, these claims would turn into thin air," says Hans-Werner Sinn, head of the Munich-based Ifo Institute for Economic Research. "Then the Bundesbank would have to write off this amount." Given that central banks are not normal enterprises, though, Sinn's conclusion is debatable. This is because central banks have different accounting options. It is conceivable, for example, that the Bundesbank could replace the Target2 asset on its balance sheet with an equalization claim against the German national budget. This would balance the equation on paper.
As long ago as 1948, the Bank Deutscher Länder (Bank of the German States, the forerunner of the Bundesbank) resorted to this accounting trick when, for example, it gave every German citizen 40 deutsche marks following monetary reform. Some of these claims have been on the central bank's books for decades.
But this time the amounts in question are different. It will likely trigger skepticism among international trading partners if the central bank simply conjures the claims from the Target2 system out of its books. It would jeopardize the reputation of the bank's executive board members as stability oriented monetary watchdogs, and possibly even the image of the new currency.
A Conundrum for Investors
Not surprisingly, German depositors and investors are worried. What happens to their assets once the dust has settled and the euro zone has been replaced with a multitude of currencies in Europe once again?
In the short term, the prices of almost all even slightly risky securities would plunge, predicts Andrew Bosomworth. He runs the German portfolio management division of Allianz subsidiary PIMCO, one of the world's largest asset management firms. Should the euro collapse, which Bosomworth still considers unlikely, he expects investors to suffer losses for several reasons. "First, they would suffer currency losses with almost all securities that were converted back to national currencies following a euro withdrawal," says Bosomworth. "Second, they would have to expect countries and companies to default more frequently on their bonds."
Asset managers see only two ways to protect themselves against a crash of the euro zone: to invest the money in tangible assets or to get it out of Europe. "Investors should nationalize their investments, with a focus on emerging economies," advises Bosomworth.
German citizens haven't recognized yet what an abyss they are facing. If the euro collapses, not only will many people lose their livelihoods, but German retirement pensions will also be threatened. The economic success of the last few years would be destroyed, and Germany would fall back into the crisis status of the 1990s.
On the other hand, if the German government gave in to the Southern Europeans' pressure to communitize debt, the risks could even be greater. Instead of an uncontrolled euro crash, Germany could be confronted with an uncontrolled transfer union. Year after year, the Germans would have to transfer sums in the double-digit billions to Southern European countries.
Time Remains to Save Euro
The worst can still be prevented, and Europeans still have the ability to save their common currency without overtaxing the solidarity of the donor countries.
But it is a massive task. Europe's politicians must surrender power to Brussels to supplement their common currency with the political union that's been missing until now. At the same time, the Italians and the Spaniards would have to prove that they could successfully reform and modernize their economies.
So far, it has seemed as if the quarreling nations of the old continent would prove equal to the challenge, as has so often been the case in their postwar history. As experienced Brussels observers know, solutions are only reached in Europe when the continent has run out of options.
But apparently the euro crisis is now so dire that it could even sweep away the oldest European certainties. Even die-hard European politicians now believe that it is no longer inconceivable that the monetary union could soon have fewer members than before. "To push Europe forward, we have to reform the euro," says Luxembourg Finance Minister Luc Frieden. "This doesn't just apply to the management of the monetary union, but, if necessary, to its geographic composition, as well."
Reported by SVEN BÖLL, DIETMAR HAWRANEK, MARTIN HESSE, ALEXANDER JUNG, ALEXANDER NEUBACHER, CHRISTIAN REIERMANN, MICHAEL SAUGA, CHRISTOPH SCHULT AND ANNE SEITH
Translated from the German by Christopher Sultan
- Part 1: The Disastrous Consequences of a Euro Crash
- Part 2: Companies Envision Possible Scenarios
- Part 3: 'Consequences of Disaster Would Spread Like a Tidal Wave'