Three UBS analysts, Stephane Deo, Paul Donovan, and Larry Hatheway, last week released a report where they examined the consequences of a break up of the euro currency.? The outcome that at one point seemed most unlikely, is now becoming more possible, analysts suggest.
The report opens with the following critical statement: ?The Euro should not exist (like this).? The three writers of the report go on to scrutinise the structure of euro, and argue that it is prone to weaknesses and the way to make things right again would be to change the current structure of the membership rules. ?Under the current structure and with the current membership, euro will not work,? the report declares.
They claimed that the Eurozone states are more likely to be economically better off if they had never joined it in the first place. The authors view European Monetary Union basically?as ?mis-sold? or a lie. When the currency came into existence in 1999, it was seen as a way of integrating foreign exchange. With one currency, it was hoped that foreign exchange rate uncertainties or costs for trade and tourists would be eliminated and with one monetary policy, the bonds between the members would be stronger and less stringent.
However, as per the report, what politicians missed out is that although they advocated exchange rate integration, the group that lobbied euro was called the ?European Monetary Union?. A monetary union, the report said, would only be applicable in a situation where the economies in which the currency would be used? were more or less homogenous or flexible enough so that differences in economic performance could easily be corrected.
But it seems that even at this moment, UBS sees a fiscal union more likely than a breakup mainly because a break up would be too costly for any of the countries involved.
?Our base case with an overwhelming probability is that the euro moves slowly (and painfully) towards some kind of fiscal integration. The risk case, of break-up, is considerably more costly and close to zero probability. Countries cannot be expelled, but sovereign states could choose to secede. However, popular discussion of the break-up option considerably underestimates the consequences of such a move,? the report stated.
CURRENCY BREAK UP
Sovereign default, corporate default, collapse of the banking system and collapse of international trade are likely to be the consequences of a weak country leaving the Euro, the UBS executives argue. ?The cost of a weak country leaving the Euro is significant,? and ,?there is little prospect of devaluation offering much assistance? the report explains. ?As per the estimates, a weak Eurozone member leaving the euro could incur a cost of around ?9,500 (AED47,832) to ?11,500 (AED57,902) per person during the first year. That would cost around ?3,000 to ?4,000, per year over the subsequent years. This has been calculated to equate to a range of 40% to 50% of GDP in?the first year.
But how about the consequences of a stronger country leaving the Euro? According to the report, such a country, for instance Germany, were to take this step the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade.? The cost is expected to be around ?6,000 (AED30,200) to ?8,000 (AED40,280) for every German adult and child in the first year, and a range of ?3,500 (AED17,620) to ?4,500 (AED22,650) per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year.
The report states that, in comparison, the cost of bailing out Greece, Ireland and Portugal in the face of a default of those countries would be a little over EUR1,000 per person, in one single go.
Deo, Donovan, and Hatheway added their opinion on the political costs as well, saying, ?Fragmentation of the euro would incur political costs. Europe?s ?soft power? influence internationally would cease (as well as the concept of ?Europe? as an integrated polity will become meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war,? they added.
Clearly, their report concludes euro should not have existed in the first place. It also adds that rather than a break up of euro, careful steps need to be taken to ensure that the debt crisis leads to minimal damage to all countries while holding together the united European currency.
Sources: Zero Hedge, Business Insider