When Jürgen Stark, member of the executive board and governing council of the European Central Bank, gave president Jean-Claude Trichet his resignation on September 9, fear spread through the markets that the ECB might be falling apart. It was the second high-profile departure this year after Axel Weber’s in February. Weber was also known to be in opposition to the ECB bailing out sovereign borrowers.
All market participants now realise that the European single currency cannot carry on as it is, and most expect an eventual resolution to take the form of closer fiscal union. The chief obstacle to this appears to be a German electorate that never really wanted to swap its precious Deutschmarks for the new single currency in the first place. Could there be another end game?
Article 50 of the Lisbon treaty allows for withdrawal of a member state from the European Union, negotiated and approved by the European council and parliament. It sounds inconceivable that Germany could ever take this course, but it would seem to be the only alternative to closer fiscal union.
If Germany were to somehow leave the single currency, its new national currency would immediately strengthen against the rump euro. That would secure redenominated domestic savings and make continuing euro debt service for the government and German companies quite easy, though German investors might not be happy to have assets serviced in a weakened euro while having to pay their bills in a restored and strong Deutschmark.
German banks would also be left with devalued rump euro assets on their balance sheets, including exposures to sovereign, corporate and bank borrowers left in a weakened euro bloc that would probably suffer more unquantifiable contagion, as well as financial system and economic stress.
German companies, notably exporters, would be at an immediate currency disadvantage and, possibly, on the outside of the European Union free trade bloc. Workers would be laid off, leading to social tension.
UBS economists Stephane Deo, Paul Donovan and Larry Hatheway have attempted to weigh up the costs to Germany of leaving the EU and with it the euro. They suggest: “The consequences would include corporate default, recapitalization of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around €6,000 to €8,000 for every German adult and child in the first year, and a range of €3,500 to €4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year.”
And that, they say would be the least of Europe’s and Germany’s worries. Europe would lose political influence and the UBS economists also point out that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.
It’s scary stuff.
“In comparison,” says the UBS economists, “the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over €1,000 per person, in a single hit.” Its calculation is based on the euro area buying up the remaining debts, including to the IMF, of Greece, Portugal and Ireland and those countries defaulting with a 50% haircut.
