“The era of procrastination, of half-measures, of soothing and 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.
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.
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.
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.
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.
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.