When the euro began circulating in 2002, it was seen as a great step forward in the economic and fiscal integration of EU members. Now it is a source of great divisiveness, as the EU struggles to manage economic crises within the confines of the euro.
3 BREAKUP SCENARIOS
Several scenarios for partial or full breakup of the eurozone are possible. This brief explores a severe version of Scenario 1, below, which also appears to be considered the most plausible way the eurozone might come undone according to a review of recent published analyses. (It is worth noting that use of the euro and membership in the EU itself are seen as separable, even though formal mechanisms for leaving the eurozone are lacking.)
- Scenario 1: Losing PIIGS. Economic and political strains force some combination of Portugal, Ireland, Italy, Greece, and Spain (for which PIIGS is an acronym) out of the eurozone. If, on the heels of some or all of the PIIGS, France also leaves, then the eurozone becomes—in effect if not in name—an enlarged deutschemark zone.
- Scenario 2: Euro A and B. In this scenario, the euro splits into two separate currencies, essentially northern and southern euros. The northern bloc is composed principally of Germany, Austria, Finland, and the Netherlands, while the south is built around Italy and Spain. It is unclear which bloc France would join.3 This split might be triggered by German voters essentially forcing their country out of the euro bloc, instead of continuing to bail out other EU members.4
- Scenario 3: End of the euro. In this scenario, the currency ends its existence, and the countries of Europe revert to their former national currencies.
Effects of a eurozone collapse are diverse, and would range from those likely to precede a collapse to those that are likely to persist for decades.
- Dislocations to the financial system: The unraveling of countless business deals and financial transactions, and the need to create whole new currencies, would cause financial dislocation. The euro would oscillate in value, disrupting trade and finance. In exiting countries, as soon as an exit was anticipated, foreign lending would cease and trade would seize up for fear of future losses. Depositors would withdraw funds from the banking system, and the system in the exiting country would likely fail. (Banking system failure caused by sovereign default could also be the trigger for a euro exit, as the problem of lack of liquidity might only be solvable with a new national currency.)
- Recession, in Europe and beyond: A eurozone breakup such as described in Scenario 1 would trigger severe recessions in exiting countries, and might tip the entire world economy into recession. Overall impacts in the eurozone would be harsh, though estimates vary. ING, for instance, forecasts a 12% cumulative drop in output over the first two years, which is worse than the losses of the 2008 crises, but not an outright depression. In 2016, eurozone output might be 10% lower than it would have been.
- Asset price changes: Asset prices would drop in many parts of the eurozone, probably beginning before an actual breakup. Home prices, retirement accounts, and stock portfolios would all take a hit. It has been projected that even if Greece exited on its own, housing prices would drop in all the PIIGS, and a broader eurozone breakup with other countries abandoning use of the euro might cause severe reductions in home values of 18–36% in the PIIGS. At the same time, in some scenarios asset prices could be bid up. If Germany left the euro to return to the deutschemark, for instance, capital inflows could induce “a booming stock market, and soaring housing prices.”
3 BUSINESS IMPLICATIONS
- Even short-term business plans should now take into account potential effects of potential eurozone defections, of efforts to counter this, and of pan-European recession brought on by these issues.
- Among the concrete preparations that businesses should consider, analysts suggest, are writing contracts with a possible euro collapse in mind—including specifying the currency of settlement, alternate currencies, place of jurisdiction, and an alternative place of jurisdiction.40
- Hard currencies other than the euro might be driven up in value as investors turned to them. (If the dollar were in some kind of politically induced crisis at the same time, the blow to the global financial system would be even worse.)