Euro Crash

Spiegel Online
June 25, 2012

Edited by Andy Ross

Investment experts at Deutsche Bank now feel that a collapse of the common currency is a "very likely" scenario.

Two decades of progress in Europe would be lost. Millions of business contracts and relationships would have to be reassessed and thousands of companies would need protection from bankruptcy. Europe would plunge into a deep recession. Governments would have to borrow more billions to meet their needs and either raise taxes or accept higher inflation.

The fronts between governments are hardening. Italy and Spain want Germany to issue stronger guarantees for their debts. They want the money without conditions. But the German government will not accept this.

German companies are now assessing the consequences of a crash. German exports to Italy and Spain alone are valued at about 100 billion a year. Although sales of manufactured goods would not end with a euro collapse, they would fall sharply. As soon as lira or pesetas were reintroduced, the currencies would be devalued against the euro by up to 40%. German goods would automatically become more expensive and would soon be uncompetitive.

A collapse of the euro would end the single market. Regionalism could return to Europe, and countries could reintroduce customs barriers to protect domestic industry. Uniform environmental rules would be replaced by a jungle of national regulations. All of this would plunge the German export economy into a crisis.

In 2010, German companies sold goods worth about 218 billion in Italy, Spain, Portugal, Greece, Ireland, and Cyprus, with Italian subsidiaries alone accounting for 96 billion. The value of foreign direct investment in these countries is about 90 billion. A euro crash would reduce labor costs in Portuguese or Spanish factories, but on balance it would be a bust.

A crash would devastate the financial sector too. If Club Med countries left the eurozone, customers would draw down their accounts in those countries. And because financial companies in these countries are closely intertwined with the rest of the eurozone, customers would also raid their German banks. The withdrawal of several countries from the eurozone would shake the European banking system to its foundations.

If Ireland, Portugal, Spain, and Italy joined Greece in leaving the euro, 29 large European banks would see a total capital shortfall of about 410 billion. Italy and Spain account for a tenth of the European private and corporate banking business at Deutsche Bank. The bank estimates its credit risks in these countries at about 18 billion in Italy and 12 billion in Spain.

Companies are doing what they can today to brace for the crash. They are financing deals in the peripheral countries locally to avoid currency risk. Companies are receiving loans almost exclusively from banks in their own countries. Where cross-border transactions are unavoidable, banks are engaging in hedge transactions. IT systems are being prepared for a Europe with multiple currencies. And whenever they can, banks are establishing liquidity reserves or depositing money with the ECB.

The consequences of a crash would spread across the European economy like a tidal wave. In the first two years, the eurozone countries would lose 12% of their economic output. This is a loss of more than 1 trillion. In Germany, the recovery would end and banks and companies would start collapsing like dominoes.

The German Finance Ministry predicts that in the first year following a euro collapse, the German economy would shrink by up to 10% and the ranks of the unemployed would swell to more than 5 million people. Government debt would rise sharply as tax revenues declined and government spending increased. The total cost to the German economy could amount to a quarter of Germany's gross domestic product, or well over 500 billion.

Asset managers see only two ways to protect themselves against a euro crash: to invest the money in tangible assets or to get it out of Europe.

AR  This is my nightmare.