The consequences of abandoning the euro would include sovereign and corporate default generating a surge in the cost of capital, a collapse of the banking system and a collapse of international trade. Economists at UBS have estimated that the annual cost of a weak Euro country leaving the single currency would be in the region of EUR9,500-11,500 per person in the first year and EUR3,000-4,000 per person in subsequent years.
Were a stronger country such as Germany to leave the euro, the costs were estimated between EUR6,000 and EUR8,000 per person in the first year and a subsequent annual cost of EUR3,500-4,500 thereafter. Comparatively, a total bailout of Greece, Ireland and Portugal following their default, would amount to a single cost of approximately EUR1,000 per person, UBS estimates.
The systemic risks created by a single country, such as Greece, abandoning the euro are also high, the report says. That’s because it would invoke speculation about other weak economies, further increasing the relative costs of membership for these countries, which could precipitate further departures. Thus, it is unlikely that a single country would leave, meaning a change to the current membership of the euro is an unlikely scenario.
“Our base case with an overwhelming probability is that the euro moves slowly (and painfully) towards some kind of fiscal integration. The risk case, of break-up is considerably more costly and close to zero probability”, say the authors of the report, Stephane Deo, Paul Donovan, and Larry Hatheway.
However, chief economist at Lloyds Banking Group, Trevor Williams, argues the so-called muddle through approach is only an intermediate step to dealing with Europe’s deep debt issues. Whilst a departure of the most indebted nations would carry significant adjustment costs, Williams says this may be required. He argues that the long term costs of the weakest countries staying in the euro will not, and cannot be met, by Europe’s core members, for political reasons and economic reasons.
“To assume that the balance sheets of Germany and France can somehow assume all the liabilities of the eurozone’s weaker countries is a total misunderstanding of the amount of debt we’re talking about,” Williams tells EuromoneyFXNews.
For instance, if the debt of Germany goes up by another EUR220bn, its debt to GDP ratio would be 100%. This level of debt would put Germany at risk of a significant credit downgrade and the implied burden on Germany would grow unsustainably, according to Williams.
“For Greece the benefit of leaving would mean a potential halving of their debt, the option to become more competitive, stay on good terms with their neighbours and still have open and free markets. The experience of countries that have been through default shows that they do recover and it can be a solution as much as it can be seen as a problem,” says Williams.