UBS Economists on the € (Echos PIIGSty.com!)

In the PIIGSty Publication on the euro, we said there are fundamental aspects to the single currency which make its collapse or break-up next to impossible. Looks like we’re not alone in that (learned) opinion! Economists at UBS have totted up the sums on the cost of a country withdrawing from the euro. It doesn’t show a pretty picture.

Heres the PDF

Their main finding: “the Euro (as currently constituted) should not exist.”

The basic summary of their findings are as follows:

  • The euro isn’t working so either its operation or its membership must change
  • Most likely scenario: the eurozone (EZ-17) moves “painfully” toward fiscal integration

Economic Costs

  • Consequences of  a weaker country (PIIGS) leaving the euro are immense (40-50% of GDP in year 1). This includes the cost of sovereign and corporate defaults and a collapse of national banking and trade.
  • Consequences of a stronger country (Germany) leaving the euro are still immense (20-25% of GDP in year 1). Germany would avoid sovereign default and collapse of their banking system but would incur costs related to corporate default and trade decline.
  • Cheapest option? Bail out the ‘PIG’ nations (single hit of around 5.5% of GDP)

Political Costs

  • Europes ‘soft power’ would decline. Political costs are generally impossible to quantify in cash terms.

Key Points

  • Europe isn’t an ‘Optimal Currency Area (OCA)’ – in reality only small economies ever represent an OCA. Without homogeneity, currency areas need flexibility (in labour migration, wages, prices  – all coordinated by fiscal stabilisers). The eurozone doesn’t have this.
  • Voluntarily Leaving the euro/Expulsion from the euro is NOT risk free – a Swiss-sounding ‘fiscal confederation’ is required to save the euro. Secession is very complex (legally and economically). Expulsion is the same (legally). Both would requirement amendments to EU Treaties – and under current unanimity rules, a country facing expulsion would have to vote in favour itself (which turns expulsion into succession).
  • If a weak country surrenders and just gives up the euro – the costs are huge including sovereign debt default, banking collapse, end of EU membership, trade disruption/return to protectionism and civil unrest.

One silver lining is that, historically, “the break-up of a monetary union is a very rare event and extremely unusual.” The wider EU needs to head toward political union and fiscal coordination/confederation via strengthened economic governance or the deep unknowns in a ‘worst case scenario’ would become reality.

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