What happens if the Germans or Irish leave the euro?
More and more clients, both European and American, have been asking us about the debt crisis in the EU.
Aside from wishing to do what I can to address their concerns, I´m extremely interested in this subject as Torcana holds a substantial amount of euros, dollars and British pounds. I also have personal savings and/or investments in Ireland, Spain and the UK.
You can tie yourself in knots thinking about this though, as every economy is so closely tied to its trading partners.
One of the options being floated is that Ireland should consider leaving the euro. This to me would be a disaster. If the Irish left the euro and converted back to the punt, the currency would depreciate rapidly against the euro. For simplicity, lets assume 1 euro = 2 punt. That would lead to an export boom, since overseas buyers could purchase Ireland’s goods for half the previous price. The flip side, is that everything you import is also twice as expensive.
More importantly, Ireland would have to earn 2 billion punt for every 1 billion euro owed to the EU, the IMF and other international creditors. They could never hope to do that and Ireland would have no choice but to default on these debts. The bond markets would shun Ireland for years - would you lend to a person who already defaulted on previous loans?
This would lead to a severe liquidity crisis as a huge number of businesses and individuals would wish to withdraw their money from Irish banks and deposit it elsewhere. Those who didn´t act quick enough would see the value of their savings wiped out as the punt depreciated even faster against the euro. Companies like Microsoft, Dell, Facebook, Ebay & Intel would all run for the hills, probably the hills of Poland.
In other words, I cannot envisage any scenario that would see Ireland volunteering to leave the euro. There is far too much to lose.
What happens if Germany goes?
With Spanish, Italian and even French debt causing market jitters, a much bigger worry seems to be that Germany will cut its losses and leave the rest to fend for themselves.
Looking at the bigger picture: if Germany leaves the euro and converted to dmarks, the dmark would appreciate rapidly against the euro (as a euro without Germany would be much weaker) and their exporters would suffer a lot. A strong export economy is very important to a country like Germany with comparatively low domestic demand.
Additionally, the value of all the hundreds of billions of euro loans they´ve lent to other EU countries and banks would depreciate against the dmark. This double blow would be extraordinarily painful for the German economy and they would wish to avoid it at all costs.
In the coming year, Germany´s choices may boil down to (a) leave the euro and suffer the consequences outlined above or (b) stay in the euro and use its strength to guarantee the debts of weaker EU economies. While they certainly don´t want to guarantee the debts of weaker EU economies, my feeling is that they will ultimately prefer to do this than suffer the consequences of leaving the euro or letting it fail. It is becoming increasingly obvious that hundreds of billions of euros will either need to be guaranteed or written off by third parties like Germany, and it will be an incredibly messy process.
Nobody, not Germany, not France, not Holland, is going to guarantee the debts of Greece, Italy, Ireland, Spain etc. if there is the slightest chance they could simply spend their way into trouble again in 5 years time. In other words, they would insist that these countries hand over some of their power to tax and spend.
Even if there was the political will to do this (which there isn´t), many countries would be constitutionally obliged to put this to their citizens via a referendum, which would almost certainly be rejected.
If and when the cost of borrowing for Italy and Spain creeps up towards the 7% range, this will all come to a head (again). A way must be found for Germany & France to guarantee the (enormous) debts of these countries without putting their own finances at risk.
This is definitely possible, as the overall EU debt as a percentage of GDP is a managable 88%, compared with 98% in the USA, 200% in Japan and 83% in the UK. The annual EU deficit would be approx 4% of GDP, far lower than the 10% in the US and 8.5% in the UK.
At a time when the American congress is as polarized as it has ever been, it is worth noting that the Europeans have a certain genius for coming up with messy, drawn out compromises that get the job done.
Colin Murphy, Director
Torcana.com
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