Ambrose Evans-Pritchard writes about how the gurus nominated for the prestigious Wolfson Economics Prize discuss the breakup of the euro. First up is Neil Record from Record Currency Management.

“The consequences of a completely unplanned ‘Exit’ are likely to be catastrophic,” said Neil Record from Record Currency Management, one of the five qualifiers.

Mr Record believes piecemeal exits by one country at a time – the most likely outcome on current policy settings – would be “a recipe for continuous crisis”. There can be no such half-way house in any case. As soon as one country leaves EMU, the euro will lose its aura of inevitability. The charisma drains away.

He advocates a secret German-led “Taskforce”, with a French cameo role for the sake of “legitimacy”. Any broader planning would leak. The European Central Bank and the European Commission would be kept in the dark since they are “not well-equipped to design the demise of their own ‘great project’”.

“Failure to maintain secrecy would almost certainly lead to a complete freeze in the markets, making it impossible to finance eurozone member states’ deficits. This could accelerate a vicious circle … and possibly overwhelm the ECB. This is the stuff of nightmare,” he wrote.

The Taskforce would drop its bombshell on EU leaders on a Saturday morning. There would be a return to national currencies the same day. Any attempt to preserve a core euro would be unworkable since complex contracts worth hundreds of billions would leave a legacy of “ruinous litigation”, he said.

The only option would be to “force the legal frustration of all outstanding euro contracts” by abolishing the currency altogether. This would wipe the slate clean.

And what happens straight after it?

North European banks would face a brutal devaluation of Club Med debt. They would have to be recapitalized by their governments. The ECB would be shut down, with power reverting to national capitals.

Such a framework would allow Europe to “prosper again”. Foreign exchange markets would adjust “very quickly” once the boil was lanced. “Exit could start a new vibrant period in Europe’s history,” he said.

Then Jens Nordvig and Nick Firoozye from Nomura said

once the first state leaves EMU there will be a chain-reaction to Spain or Italy, causing havoc for currency swap contracts, and interest rate derivatives. “We believe that even if a break-up begins to unfold in an ‘onion-peeling’ fashion, it will eventually spin out of control and turn into a ‘big-bank’ break-up of the eurozone. An Italian default and exit would likely bring down large parts of the eurozone banking system.”

French banks would buckle, setting off a crisis that would push French public debt towards 120pc of GDP. “Capital controls would be a distinct possibility, at which point the euro would be obsolete”.

Mr Nordvig said policy makers must face the hard truth since credit markets are already pricing in a 30pc chance of Italy defaulting. “Euro adoption was supposed to be ‘irrevocable’, but the genie is out of the bottle. Foreign investors around the world, as well as institutions within the EU, are already trying to make contingency plans for a eurozone break-up. There is even evidence that some regulators outside the eurozone are asking banks to submit contingency plans for various eurozone break-up scenarios. Against this background, the cost-benefit analysis of planning ahead versus pretending that a break-up is not possible has shifted.”

EU leaders must spell out contingency plans right now to calm investors, above all by clarifying the jurisdiction of €14.2 trillion of debt. There should be a new European Currency Unit (ECU-20) ready to redenominate assets, if needed.

Catherine Dobbs, a former algorithms expert at Gartmore has a slightly different view on this

calling for a new settlement currency if the bloc splits into a hard core and weak periphery. Old euros and euro contracts would be treated equally. “There will be no impact on the solvency of financial institutions that have euro-denominated assets and liabilities that are unmatched,” she said.

Jonathan Tepper from Variant Perception said

Exit is the cleanest way to “re-balance Europe” and end the deflationary bias in the system. This may mean “crystalising losses” but they already exist in any case.

Mr Tepper said there have been at least 100 currency break-ups or exits over the past century, including the Austro-Hungarian union (the closest parallel), and Soviet, Czechoslovak, and Indian unions. They offer a roadmap of orderly divorce. The experience can be quick and liberating.

Devaluation episodes in Asia (1997), Russia (1998) and Argentina (2002) show the pain is sharp but short, followed by growth within two to four quarters. Dire warnings proved wrong in each case. Argentina rocketed back with 26pc growth over the next three years.

 

 

Advertisements