The Union Bank of Switzerland (UBS) has just released a report titled “Euro Break Up—The Consequences,” wherein they predict the death of the euro and the long-term consequences should that occur.
The report starts out cheerily enough: “Under the current structure and with the current membership, the Euro does not work. Either the current structure will have to change, or the current membership will have to change.”
Oh, well. That’s all.
The report then proceeds to calculate what it would cost a country should it decide to resign from the euro zone. What is truly interesting, as it is astutely pointed out by Zero Hedge, is that the report focuses a great deal of attention on Germany. This signals one thing: Germany, the most effective and prosperous of all the European countries, may be considering an exit from the euro.
As a result of this widespread belief, it would seem that portions of the report were written in an apparent attempt to dissuade the Germans from a hasty departure:
Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalization of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around €6,000 [$8,400] to €8,000 [$11,200] for every German adult and child in the first year, and a range of €3,500 [$4,900] to €4,500 [$6,300] per person per year thereafter. That is the equivalent of 20 [percent] to 25 [percent] of GDP in the first year.
It is without doubt that a German exodus would result in an almost instantaneous diminution in Europe’s fiscal and social stability. Who would replace them?
What is especially discomforting about the report is that the UBS, an organization with an almost hegemonic influence over the world economy, has no faith in the system to which they are intimately attached.
The UBS is the world’s second largest manager of private wealth assets and maintains over $2.68 trillion in assets–much of it invested in Europe andEuroassets. It would therefore be perfectly reasonable to claim that should the euro go, then so too the UBS.
However, regardless of the social implications, the financial loss, and in spite of all of Christine Lagarde’s moral posturing, it looks very much like Germany, the most economically stable country in Europe, is ready to abandon the euro.
Rather than simply paraphrasing the starkest predictions of the report, it is best to present them in their full context:
The rest of the Euro area (indeed the rest of the European Union) is unlikely to regard secession with tranquil indifference.
The European Commission explicitly alludes to this issue, saying that if a country was to leave the Euro it would “compensate” for any undue movement in the NNC. It is also important to note that exiting the EMU, as we note above, means exiting the EU. This would leave the country departing with no trade agreement-with Europe
The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade [emphasis added]. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around €9,500 to €11,500 per person in the exiting country during the first year. That cost would then probably amount to €3,000 to €4,000 per person per year over subsequent years. That equates to a range of 40% to 50% of GDP in the first year.
The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s “soft power” influence internationally would cease (as the concept of “Europe” as an integrated polity becomes 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 [emphasis added].
The report goes on to clarify that last point on armed conflict:
If we consider fiat currency monetary union fragmentation, it is fair to say that the economic circumstances that create a climate for a break-up and the economic consequences that follow from a break-up are very severe indeed. It takes enormous stress for a government to get to the point where it considers abandoning the lex monetae [monetary law] of a country. The disruption that would follow such a move is also going to be extreme . . . When the unemployment consequences are factored in, it is virtually impossible to consider a break-up scenario without some serious social consequences.
After walking through all of these dreary scenarios, the report actually concludes by asserting what many economists have been saying for years: “The only way to hedge against a Euro break-up scenario is to own no Euroassets at all.”
In the words of Zero Hedge: “[the] UBS just unwittingly announced the final countdown for the EUR.”