Carl Hasty, Head of Trading at Smart Currency Exchange, looks at the prospects and implications of the potential collapse of the euro - originally published in Business Scotland magazine, October 2011.
It is now 12 years since the European single currency – the euro – came into existence, with 2002 being the year in which euro notes and coins were officially introduced.
For many, the euro was seen as a natural continuation of further and deeper European integration. While the likes of the UK and Denmark chose to stay clear, this new currency has, for the majority of its lifetime, proved a success. Talk to any UK exporter and they will tell you about the convenience and greater certainty of dealing with just one currency across the EU, the world’s largest free trade zone. And yet the euro has started to wobble.
Poorer member states such as Portugal, Ireland, Greece and Spain (the PIGS) are struggling with huge debt problems. At the time of writing an EU summit is due to take place on the debt crisis to allow ministers to bolster indebted European banks and finalise the next tranche of Greek bailout money.
So what is the likelihood of the euro collapsing and what are the implications? Many see its downfall as highly unlikely, arguing that the political will within the European Union is simply too strong – and consequences too dire – to allow it. That said, there have been some worrying signs coming out of Europe.
Pipi Malmgren is a consultant for Deutsche Bank and the former Special Assistant to the President of the United States for Economic Policy on the National Economic Council. She was recently quoted in the press as saying that Germany will abandon the euro and reintroduce the Deutschmark.
“The markets are very likely to have to contend with the re-introduction of Deutschmarks in the near future…this step may seem unthinkable but I believe that the German government is telling us in multiple ways that there is no other solution from their point of view,” she said.
Add to this the fact that the German public is said to be growing disillusioned with its government’s key role in helping bailout Greece – and possibly soon other states – and the crisis facing the euro becomes even more apparent. Germany, let’s remember, is the anchor economy within the euro.
IMPLICATIONS OF GREEK WITHDRAWAL
There are several possible scenarios as to how the eurozone might unravel. The first – and possibly the one you’d get shortest odds on from a bookmaker – is Greek withdrawal. As far as practicalities go, this would see all Greek bank accounts redenominated into drachma and prices following accordingly. The ‘new’ currency would be weak, a reflection of the huge structural challenges facing the Greek economy. As such, the run-up to Greek withdrawal may see a run on Greek banks as depositors sought stronger currencies or assets.
Further shrinkage of the eurozone, with the withdrawal of other poorer countries such as Spain, Portugal and Italy would, again, see these countries return to their previous currencies. Again, these currencies would be weak and capital would likely flow from such countries in the run-up to withdrawal. Good news, then, for holidaymakers; bad news for UK firms doing business in these parts of the world.
In theory, the exit of poorer countries from the euro would boost the exchange rate of the euro against other currencies around the world. Accordingly, the UK’s trade position against some of its key European trading partners would profit from an effective devaluation of the pound.
THE NIGHTMARE SCENARIO
A complete collapse of the euro is the nightmare scenario. Such a scenario could pan out in several ways. What seems certain, however, is that a total collapse of the euro would cause chaos in global markets. Confidence in some currencies would disappear while others would become hugely valued – creating massive issues for businesses in these countries in terms of their ability to compete abroad.
Other likely outcomes: we might see a rise in protectionism; we’d almost certainly see a scramble for hard assets such as precious metals; we may even see growing hostility between former members of the eurozone. Confusion would reign as the markets reacted in the only way they know how to react to the kind of uncertainty an event like this would create – sporadically.
Various estimates have been made about the impact of a collapse of the euro on the GDP of EU countries. Some go as high as a 50 per cent reduction for poorer EU states and 25 per cent for richer ones. Halve these figures and they still look dreadful.
The coming weeks and months will see more ups and downs in the Eurozone and more heated debate amongst European leaders about how best to address the monumental challenges facing some of its poorer member states. Bailouts might not seem an ideal option but they may well be a necessary evil. The alternative doesn’t bear thinking about; the stakes couldn’t be higher.
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