1. gaius marius says

    i can’t imagine a breakup. it may be costly politically and economically for germany to change its constitution (or interpretation thereof) and accept a supranational fiscal agent/transfer union/eurobonds. but that is only if germans look only at the expense side of the ledger.

    what about the income side? who do germans think they export to, exactly? the health of germany in the eurozone has been built in large part on the backs of the peripheral countries whose domestic industries it exploited. now they’re being asked to pay that piper, and if they refuse they’ll find the price is the remorseless collapse of their vaunted german export machine into a pit of depression.

    if the germans want to find themselves in the world of scheisse that michael lewis intimated they secretly desire, they should allow schauble to continue to insist on the periphery devaluing internally while trying to close national deficits that cannot as a matter of mathematics be closed short of regional poverty. what idiocy this is!

    1. Edward Harrison says

      Politics is not driven by economics, especially during deep downturns. Economic nationalism becomes ever more a factor for politics the deeper the downturn gets. In the event of a second downturn, we should expect nationalism to favour default and breakup irrespective of the economic consequences. The goal is to rid a country of the euro’s yoke once and for all, come what may.

      Look no further than the debt ceiling debate to see the kind of extremism that becomes commonplace. Threatening default was seen as a necessary political choice to rid the country of the ‘big government’ yoke once and for all. This is the kind of politics that we will see more.

      1. gaius marius says

        i can’t argue that you’re wrong, edward, much as i would like to. reflective pragmatism too often dies just when it’s needed most.

      2. Mystic says

        Yes Edward…Politicians….
        The scene that comes to my mind is the one in Kill Bill 2 when one chick pulls the other chick’s eye out.
        I see the politicians acting something like the chick sans eyes.
        (not pretty)

        1. Edward Harrison says

          Mystic, hi, good to hear from you! Politics is ever more important now because the advanced economies would be in a deep depression right now were it not for the policy response. But the whole affair has a dithering quality to it as they have protected vested interests (banks principally). People are getting fed up with this and sooner or later the politics will get so volatile somewhere a politician will make a fatal mistake. We have played extend and pretend long enough. If we get a second dip in GDP, that’s when the chick sans eyes will appear to vent her spleen.

  2. Ramanan V Iyer says

    Very well written. One of the very few articles which makes distinguishes a true supranational fiscal authority from Special Purpose Entities such as EFSF – even though the latter is termed “supranational”

  3. Ken Smith says

    A clear analysis. This has been lacking almost everywhere else. It explains gold’s (no longer inverse to the dollar) movements perfectly.

  4. David Lazarus says

    I do see Greece leaving first. Then, maybe a few months later Portugal. Ireland will hold on for dear life because much of their foreign direct investment is totally dependant on being within the eurozone. Though if Greece starts to recover quickly then I see Ireland leaving as well, especially as its recovery is very sluggish. It might even fall into depression as the rest of the Eurozone slumps into recession. Spain and Italy might survive but Italy looks weaker than Spain right now. The politicians will probably fight this outcome because their reputations rest on it.

  5. Ben says

    Great post as always Edward. I don’t understand where the initial money for the Harmonsation fund would come from, since it would be commencing in a cyclical downturn. would they print it or would the Germans pony up?

    1. Edward Harrison says

      Ah, you are onto the real problem. Getting from here to there is tough. The only way to do it right is to have sovereign defaults, debt writedowns and bank recapitalisations. That would give the euro zone a reset.

  6. Douglas says

    The peripherals reduce the value of the Euro. Without them or Germany on its own the resulting currency would be at least 40% higher and German exports no longer competitive. Germany and its export economy benefits tremendously from the inclusive Euro. Now it wants to punish or expel the very countries whose participation in the Euro makes the German economy thrive. It can’t afford a breakup. Politics being what they are may still drive Germany in this path.

    Default and exit from the Euro may, however, benefit the peripherals. Especially if they adopt EuroII or if Germany et al exit the Euro

    1. David Lazarus says

      Greece and Portugal will benefit from a weaker currency enabling them to become more competitive. It will also get a tourism boost. Inflation will increase as a result of the weaker currency, but the issue will be how the pain is distributed.

    2. Edward Harrison says

      Douglas, when you talk about the euro’s value, you are probably talking about the value of a strong euro vis-a-vis a new Greek, Italian or Spanish currency. Right now the euro is already overvalued with respect to the dollar, so it wouldn’t rise 40% against the dollar from here without the periphery. Remember it was introduced at 1.17 and traded to as low as 0.83.

      1. Douglas says

        I took the 40% figure and the rational re German exports from the 21 page FT article your site linked to yesterday.

      2. David Lazarus says

        But a Eurozone without the periphery will have a much stronger euro. Will they be able to maintain exports at such a rate with a stronger currency? The smaller Eurozone countries will suffer maybe even be considered a sovereign risk themselves. Germany might be the last to feel the effects, but outside the euro with a new Deutschmark, they might have the same problems as the Swiss.

  7. Douglas says

    I double checked. The article is UBS: Euro break-up – the consequences. Here’s an excerpt:

    So what is the cost of a “stronger” country leaving? The same problems with modelling apply to a strong country departing as a weak country – this is such an abnormal event as to be all but impossible to simulate with any great certainty. However, we can make some assumptions about the basic costs. The seceding strong currency is likely to have an appreciation of 40%.
    Further, the exit causes a growth shock to the rump Euro, which undermines the export potential. We have
    assumed a 20% reduction in trade. This is very conservative, but it needs to be seen in the context of the 40% appreciation of the NNC, which will create an
    obvious additional drag on trade.

    1. Edward Harrison says

      Those numbers are too high in my view. What UBS is saying is like what David Lazarus is saying, that there will be a speculative move into Rump-euro and it would end up trading like the Swiss Franc (or the yen).

      We might see a moonshot like that just after the EZ broke up but eventually the currencies would fall in line closer to purchasing power parity (which is below where the euro is now). But clearly this is all just speculation because the fundamentals don’t support this since purchasing power parity is quite a bit lower.

  8. emma says

    From my point of view, living in rural Portugal, leaving the euro zone would be the best thing for this country. Portugal would return to a familiar lifestyle of self sufficiency and, although stifling, economic independence. The only way to meet the debt crisis is through radical political strategy, and this country, just like Greece, does not have the stomach for radicalism. The only difference with Greece is that there will never be riots here, and the escudo may even be welcomed back.

    1. David Lazarus says

      I think that Portugal will protest and even riot if that is the only alternative. It also depends on how the government react. If they ignore the public then anger will grow, if they send the police in against protestors then watch the fall of the government. Much will depend on the electoral timetable. If the next elections are years away expect protests. Especially if the government ignore the people. Greece is very vulnerable. I suspect that the governments of the periphery will fall. Default is the only option and with an escudo the tourists will return.

  9. Gail Tverberg says

    With oil prices high, it tends to cause recession (especially among oil importers). Governments attempt stimulus and bail outs, but it only gets them deeper in debt. These issues add a whole new dimension. Means that there is little chance that over the long term the problems can be worked out, regardless of what will happen. Some US states are in financial trouble. Over the long term, the US government is likely to be also, IMO.

    1. David Lazarus says

      If the US had ignored the lobbying from the Automakers and Big Oil it would probably have a lower trade deficit and that would have meant a lower fiscal deficit. The US needs a green energy program to cut oil usage so that its trade deficit falls considerably. This would take a lot of the pressure off the fiscal deficit.

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