UBS: Euro break-up – the consequences

The following is excerpted from today’s UBS research note by Stephane Deo, Paul Donovan and Larry Hatheway on the consequences of a euro break-up. The full note is embedded below.

Also see The recession is over but the depression has just begun which predicts an austerity that leads to the more “muscular form of government” UBS sees. On eurozone break-up, see Nouriel Roubini’s post “The Eurozone Could Break Up Over a Five-Year Horizon.”

The Euro should not exist (like this)

  • 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.

Fiscal confederation, not break-up

  • 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 can not 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 economic cost (part 1)

  • 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. 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 EUR9,500 to EUR11,500 per person in the exiting country during the first year. That cost would then probably amount to EUR3,000 to EUR4,000 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 (part 2)

  • Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over EUR1,000 per person, in a single hit.

The political cost

  • 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.

  1. David Lazarus says

    I think that the claims of a country leaving the euro and defaulting are exaggerated. While Iceland did not have to deal with leaving a currency its GDP was not as savagely impacted as this report suggests. In fact it recovered after an initial fall immediately after the default. My concerns are that for a country to stay within the eurozone under such austerity will result in revolution. That will have serious problems. The impact of such upheaval will lead to mass migration and refugees across Europe. The problem for governments is that to stay in means decades of austerity and sub par growth, poverty on a scale not seen for more than a generation and either revolutions or serious clampdowns on freedoms to prevent violence. I can not see the public in all of the countries tolerating that to make sure that bankers get their bonuses.

  2. Detlef says

    I´ve got a few problems with that research note.
    The bailout costs seem to be based on a best-case scenario while the costs of leaving the Euro seem to be a worst case scenario?
    (for “stronger countries”)

    1. I notice they didn´t even mention Italy or Spain. The big countries / potential problems. Bail out 3 small countries / problems (Ireland, Portugal, Greece) and magically all other problems vanish?

    2. I notice they quite rightly mention and calculate the costs of a “recapitalisation of the banking system” should a strong country like Germany leave the Euro. Curiously enough they don´t calculate the costs of a 50% haircut in their cheaper bail out scenario. I suspect that a 50% haircut on existing Greek, Irish and Portuguese debt would also result in a need to “recapitalize the banking system”. But such a bail out is just mentioned as a possibility, without any costs calculated?

    3. They argue that – according to the treaties – leaving the Euro automatically also means leaving the EU. Leading to trade disruptions and other problems.
    They might be legally right although the treaties of course also included a no-bail out clause. :)
    Politically and economically though it´s difficult to believe that the rest of the EU would insist on Germany leaving the EU, should it leave the Euro.
    It´s the largest economy in Europe, the largest net-payer in the EU and the “connection”/transit country between Western and Eastern Europe. Not to mention the economic connections between EU countries. It would basically destroy the EU in my opinion.

    Now I´m not saying that their estimates for leaving the Eurozone aren´t right. I´m just saying that their estimates for bailing out the “problem countries” seem a bit low.
    In the case of Germany the costs will be ” a little over Euro 1000 per person”. That would be Euro 82 billion. Does that sound realistic?

  3. Denison Chapman says

    This is no longer a financial crisis, and maybe never was since 2008/9, it is a power struggle between bankers and politicians amplified out of proportion by the media, over how to ensure stability, growth and a restructuring of soverign debt (soft default). The timescales and reaction times of these two groups are incompatible and in the end the politicians have to assert authority and are unlikely to let the Euro fail so I would expect increased controls over trading, short selling and the like to damp market reaction whilst the euro zone moves slowly towards fiscal integration. How this is done will have to include measures that polititions of all countries can sell to the electorate. It will take time and will inevitably look like a series of fudges at times but its the most realistic outcome. It just may come faser that you think following on the wake of the Swiss curency decison this week.

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More