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Morgan Stanley Warns Germany May Decide To Secede From EMU
A fantastic overview of all the game theory aspects embedded in the European crisis, from Joachim Fels, head of Euro research at Morgan Stanley.
- Somewhat paradoxically, the show of solidarity for Greece by other euro area members and the ECB raises the risk that the euro will break apart eventually.
- Seceding from the euro area to devalue is very costly and risky. But seceding to revalue and introduce a harder currency is easier. Germany might opt to do so one day.
- The road to such a break-up scenario leads through even more fiscal profligacy and divergence in the euro area, a politicisation of monetary policy, and a weaker currency. Recent events suggest that the trip down this road has started.
A pyrrhic victory… The joint euro area/IMF financial backstop package and the ECB’s recent climb-down on its collateral rules have clearly reduced the short-term liquidity risks for Greece. However, as our European economists have emphasised, long-term solvency risks remain firmly in place. More broadly, and more worryingly, recent developments significantly raise the (long-term) risk of a euro break-up, in our view.
… which gives rise to moral hazard: The bail-out and the ECB’s softer collateral stance set a bad precedent for other euro area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time. If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union. And because the Maastricht Treaty does not provide for the possibility of expelling euro area members, the only way how Germany could achieve this would be by leaving the euro to introduce a stronger currency.
Seceding to revalue is easier: It has been our long-standing view that such a break-up scenario – where a country or a group of countries want to leave to introduce a stronger currency – is more likely than a scenario where a country wants to leave to devalue. The reason is that the costs of leaving to devalue are extremely high.
- First, borrowing costs for the seceding country would likely rise significantly as investors will demand a currency and inflation risk premium.
- Second, while contracts between parties in the seceding country could by law simply be redenominated in the new currency, redenomination would not easily apply to cross-border contracts. Foreign creditors would still demand to be repaid in euros (‘continuity of contract’). Thus, a country that secedes and devalues would still have to honour its foreign-held debt in euros and would thus face a rising debt burden. If it decided to default instead, it would, at least for some time, be totally shut off from foreign financing.
- Third, a country that decided to leave the euro to devalue would immediately face a bank run by domestic depositors who would want to shift their funds into banks in other euro area member countries. This would provoke a financial meltdown which could only be prevented by a freezing of bank deposits and the imposition of strict capital controls.
By contrast, none of these costs would apply for a country that wanted to secede in order to revalue. Its borrowing costs would likely fall rather than rise as it would attract an inflow of funds
How it all started... None of these deliberations are new. In fact, we first started to worry about a potential euro break-up along these lines in 2003-04 in a series of notes (see, for example, Euro Wreckage? January 22, 2004, and Debating ‘Euro Wreckage’, February 9, 2004, with a reply by Noble laureate Robert Mundell). Back then, it had become increasingly clear that the move towards political union in Europe had stalled, partly because the EU has simply become too large and diverse a club due to successive enlargements. Moreover, the old Stability and Growth Pact (SGP), which was meant to ensure fiscal discipline within the euro, was effectively buried in late 2003 when both Germany and France kept violating the 3% budget deficit limit. It was later ‘reformed’ into a toothless tiger that allowed for much more fiscal flexibility. Thus, we worried about an increasing divergence of fiscal policies with widening bond yield spreads and increasing political pressures for an easier monetary policy stance, which could make the monetary union unpalatable for countries like Germany.
…and why it has become more likely now: Obviously, we have not reached the end-game yet. However, with the recent developments, such a break-up scenario has clearly become more likely, for two reasons. First, the lesson for other euro area members from the Greek bail-out package is that no matter how badly you violate the SGP guidelines, financial help will be forthcoming, if push comes to shove. This introduces a serious moral hazard problem into the European equation. Fiscal slippage in other countries has now become more rather than less likely.
Second, the ECB’s climb-down on its collateral rules regarding lower-rated bonds, which ensures that Greek government bonds will still be eligible as collateral in ECB tenders beyond 2010, adds to this moral hazard problem and confirms that the ECB is not immune to political considerations and pressures.
Don’t get us wrong: It is quite obvious that if Greece had not received a financial backstop package and if the ECB had stuck to its previous pronouncements on the collateral rules, the consequences not only for Greece but the whole euro area financial system and the economy could have been dire. However, the unintended consequence of such action is that it sows the seeds for potentially even bigger problems further down the road.
What are the signposts that would indicate our break-up scenario is in fact unfolding?
- First, watch fiscal developments in other euro area countries closely: Our suspicion is that the aid package for Greece lessens other governments’ resolve to tighten fiscal policy, especially in an environment of ongoing economic stagnation or recession.
- Second, watch ECB policy closely: If the ECB turns out to be slow in raising interest rates once inflation pressures return, this would be a sign of a politicisation of monetary policy.
- Third, watch the political debate in Germany: Support for Greece has been extremely unpopular and fears that the euro will turn into a soft currency abound. If the aid package for Greece, which so far is a backstop credit line, becomes activated, eurosceptic forces would receive a significant further boost. And, needless to say, if other countries also needed financial support, this would further strengthen euro opposition.
Bottom line: To be clear, we neither advocate a euro break-up, nor is this our main scenario. However, the risk that it happens is far from negligible and the consequences for financial markets would be very severe. Hence, investors ignore the euro break-up risk at their own peril.
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BREAKING NEWS: The Pope is Catholic!!
Really, who didn't see this coming?
MS: Tomorrow's yesterday's news
+1
Seriously... they get paid for this?
really ? it has all the insight of a 1st year graduate with a Bloomberg terminal
Deutschland über alles
Yeah, except their demographics are awful. All that organization and discipline but not enough kindern these last few decades. If Finance, seen from a large enough distance, is about older people lending to younger ones, well that's about all Germany can do, looking forward, lend and hope for returns. Any thoughts who they should lend to?
Bugs....bunny
your little quote
is on the munny
the 4th Reich is in
the time is now
Paperclips... re-member
buy the dips
and
Mark my words
Deutsche ly!
In the long long long view, cui Bono?
And no, I'm not referring to the Irish
u 2 brutu?
back to regular programming: who wants to be a lira millionare
So what's a million lira worth nowdays, about $100 USD?
I think the question is:
Who wants to be a lira quadrillionaire?
Let's go ask the the good folks in Zimbabwe!
If Germany goes it alone I am definitely gonna get me some of that! Let's see, hard currency or ZimBen clownbux. Tough decision, NOT!
"ZimBen clownbux"
can't wait for the new picture on these....are they just amusement ride tickets?
http://209.197.93.201/TrillionDollarBill-Bernanke-small.jpg
those zeros are hypnotizing .... and is anyone else tired of his constant mug on the sidebar ads here??
If Germany secedes, you can definitely kiss the EU and Euro goodby.
Fck the Brusslecrats.
Wouldn't it invite a massive trade war as well? Most of their top trading partners are from the Eurozone.
Uh, which exports are more valuable and important, those of Germany, or those of virtually the entire rest of the EU?
Anyone? Bueller? Anyone?
France is still one of Germany's top trading partners both import AND export. It can't all be wine can it? :)
+100
Well it reduces the pool of availble reserve currencies. The dollar does not neccesarily become more attractive, but a move into the dollar would give "extend and pretend" a longer lifespan.
ding ding ding!!
Bullshit.
This is at best a sensationalist "analysis" coming from MS and at worst a short term market manipulation in the currency markets. It would not surprise me; they have 5.4 billion of loses to recover. There is no way Germany will leave EMU since it is dependent on European consumption of Germany's manufacturing output.And what facilitates Germanys near monopolistic status in Europe is the EURO. Bringing back the DEM will achieve nothing, except, maybe, gain a few points for some nationalistic sides of German political isle. If the hint of such a move comes it will come from someone inside Deutsche Bundesbank or the government and even then it would only be a Merkel dictate piece of cheap rhetoric in order for her to gain some points in the upcoming election.
"There is not way Germany will leave EMU since it is dependent on European consumption of Germany's manufacturing output."
Germany is the #1 producer in that part of the world (it’s been that way for the past 150 years). Being a member of EU will not change anything in that equation.
How would the other nation states pay Germany for the goods? In gold?
The same way Canada pays the US, and Korea pays China, etc. You don't need to be in the EU to trade with your neighbors.
Yes but those countries are independent and their political unity does not equal monetary unity as does the EU. Also IF the DEM is re-introduced it would have to be pegged to the EUR in the same manner RMB is pegged to the USD. If it was not it would be potentially harmful given that ECB could easily manipulate EUR to bring GER back into EMU. And if GER does peg the DEM to the EUR, the EU itself could FORCE GER to get back into EMU via "democratic" procedure. Also countries which participate in the EMU and the countries which participate in the EU, but not the EMU could make independent political/economic decisions and further reduce Germany's influence on both political and economic spectrum. Also EUR itself is backed by nothing else than the faith in the countries which participate in the EMU and their FUTURE economic strength[output], and it is unnecessary to say that Germany is a big part of the said faith. Given all this i do not think Germany would gamble its current position by doing something that was preaching against for more than 30 years.
you act like Germany is a wallflower country... lets see if the Euro lasts as long as Hitler did.
Goodwins Law
Aaaaaaaaaaaaaaaaaaaaaaaaand you are OUT
not when actually talking about the resolve of that country's history... but kneejerk mentality makes life easy.. your algo reply engaged eh?
If Germany left the EU, other countries will follow them to establish a smaller currency union. There is no way the smaller countries would let their economies get raped by France and Club Med.
I would assume Germany would go it alone (in the remote event of it quitting the Euro) but if it did decide to invite select Eurozone members to join a Euro#2, it would HAVE TO invite France. Not to do so would be politically catastrophic - every strand of the franco-german political bond developed since 1945 would simply unravel.
Hey CB, good Analysis.
But I have a penchant for words as symbols (powerful ones) and doesn't everyone know that EMU's cannot fly?
They can take long hops at best!
;-)
yes, but, the federal reserve bank wants to keep the dollar as the reserve currency of the world. if the euro falls apart, thats good news for the dollar. it also reduces opec's treat of a basket of currencies. don't underestimate the wall street mob. they got all kinds of sneaky shit goin' on.
Not like in a teenage outburst as MS pictures. With analysis like these no wonder MS had a bad quarter, to put it mildly.
Most bankers are just a few points more intelligent than a bucket of cum.
rotflmao
Ha! CB, you are right on the money. Germany has a couple of problems, a weak hand at the negotiating table in Brussels (as evidenced by the Italians and French backdooring them last weekend with Greece's latest 'bailout') and the strong euro relative to the dollar/yuan. Forcing fiscal discipline on their neighbors is not only politically tough but if they actually succeed causes the euro to strengthen as it will appear like Germany is driving the bus and therefore fiscal discipline could be restored. So they'll gain negotiating leverage but also gain a strong euro in the process. This is suboptimal. What the Germans want most is a weaker euro to improve the competitiveness of their exports and a better negotiating position vis-a-vis their Euro pals to avoid future 'moral hazard bailouts'. The best way to accomplish this is to talk like you're going to leave the euro but never actually do it. If Germany actually leaves the EU, they will be worse off and so will everyone else in Euroland. Sure, Germany may be relatively better off than the rest but still worse off than they are now. The mere threat that Germany could leave the euro will force the FX markets to price in a weaker euro while simultaneously forcing the other EU members to give ground on future bailout discussions. Therefore, Germany will threaten to leave the EU and re-establish the Dmark but never actually do it.
Wow so there might be a country out there that gets pissed about bailing out foreign countries? Shame it couldn't have been America. Go get some Germany!
"I've been wrong so far, so I don't have too much confidence in my view. But I think within the next 10 to 15 years the eurozone will split apart. The British government, on balance, should stay out of it."
Milton Friedman, Financial Times, June 06, 2003
WOW Gross has been all over German Bunds 1Q, maybe hes got a lead on this....
http://online.wsj.com/article/SB10001424052748704211704575139953208534226.html?mod=WSJEUROPE_hps_LEFTTopWhatNews
BY STEPHEN FIDLER
***** "A U.S. senator threatened retaliation if European Union proposals curbing access of American fund managers to the European market become law.
In a sign that a European effort to increase regulation of hedge funds and other alternative-investment vehicles could escalate into a broader trans-Atlantic dispute, Sen. Charles Schumer (D., N.Y.) described the European proposals as "protectionist rules that discriminate against U.S. firms and activities." *****
***** "FAZ: Germany is “no longer prepared to pay any price for European unification”
24 March 2010
A leader in today’s FAZ looks at Germany’s attitude to EU integration in the wake of the eurozone crisis, arguing: “we never saw this before: A German Chancellor threatening other EU members with eurozone exclusion, doing that openly in the German Parliament. The biggest member state, which has for so long silently been the guarantee of the EU, has now openly expressed that it is no longer prepared to pay any price for European unification. The present Euro crisis is more than a monetary matter. It changes the political rules of the game in Europe.” *****
http://www.openeurope.org.uk/media-centre/summary.aspx?id=1065
The Rise of German Protectionism in the 1870s: A
Macroeconomic Perspective
http://pluto.huji.ac.il/~azussman/protectionism.pdf
http://www.zerohedge.com/forum/european-proposals-protectionist-rules-discriminate-against-us-firms-and-activities-sen-charle
Sen. Charles Schumer (D., N.Y.) : You better let our squid take a dump in your kitty box whenever it wants or there will be hell to pay!!
3 strike rule... this time around, we nuke them... instead of Japan. Besides they have some great patents I am sure we as a Country could use to make some money.
If true, Finally a country that knows what's down this road of money creation. Hmmm, is it because they have been there before, and know that that paper money can also be used to keep one warm ??? People don't want to take someone else's experiences, they want to explore themselves, I guess in about 100 years (next hyperbubble) we can say NO to inflation as well, just as the Germans are doing now... For right now we want to experience it ourselves, I hear they make some nice fire, especially if costs of heating continue to go up.
That is precisely correct. There are still Germans who remember the Wiemar Hyperinflation, and it is still within living memory as a society, and they remember what came after...
That's just bullshit. Only because it would mean the end for a lot of German companies that went European thanks to the open border policy.
You assume that Germany will not take control those companies and gift them to whomever the suits the German Government to give them too?
Based on? They have done exactly that twice before?
Germany has a certain way of doing things… over and over again.
I hope they are not Jewish Corporations… own stock in a German Company that is primarily owned by Jews… now would be a good time to get out of the stock… bond and or other corporate high yield debt.
The Germans are not to be trusted when they go into protectionism mode, says history.
http://www.youtube.com/watch?v=VRTngtsOY8Q
"The Germans are not to be trusted when they go into protectionism mode"
only if you are a Jew.. I hear Israel is so important, yet no Jews ever care to live there and worry so much more about their place in every corner of commerce arond the globe instead
yeah, the Germans are the ones not to be trusted... of course!
on Thu, 04/15/2010 - 18:01
#303171
"The Germans are not to be trusted when they go into protectionism mode"
only if you are a Jew.. I hear Israel is so important, yet no Jews ever care to live there and worry so much more about their place in every corner of commerce arond the globe instead
yeah, the Germans are the ones not to be trusted... of course!
dark pools of soros,
http://en.wikipedia.org/wiki/World_War_I_casualties
United States t 92.0 116,708 757 117,465 0.13% 205,690http://en.wikipedia.org/wiki/World_War_II_casualties
United States[56] 131,028,000 416,800 1,700 418,500 0.32I should mention that the good majority of those killed where not Jews.. you dumb fuck piece of shit.
10+ on your last sentence! And not all of us Germans were for Hitler. One of my grandfathers went AWOL and didn't see his family for 8 years to avoid being in the SS army. The other was a police officer that was killed when he refused to succumb to the SS. And we were non-Jews with over 800 years of documented German lineage.
If I were German I would definitely want to ditch the Euro. Yes, I read CB's comments, I just don't agree.
Absolutely rubbish from MS. Schadenfreude from the Anglo-saxon corner.
If Germany is serious to leave EUR, I will make an argument that California will leave the USD and Wales to leave the Pound.
I thought that California already did, with their Individual Registered Warrants they printed up, their $ version of an IOU. First steps I know, but first steps none the less.
Name one thing Morgan Stanley got right that they didn't piggy back on from JpMorgan?
This is total bullshit.
Something stinks in the land of Denmark and it ain't the cheese.
"More broadly, and more worryingly, recent developments significantly raise the (long-term) risk of a euro break-up, in our view"
Sounds more like you're setting the hooks to catch a large number of fish to squeeze the fck out of, and whence that's done, it's off to find more dikes to stick your pecker into.
Germany's Call for Removal of US Missiles in Europe Reopens Debate
http://www1.voanews.com/english/news/europe/Europes-Nuclear-Deterrent-Debated-83904482.html
Plus! 14.06.2004
http://www.cap-lmu.de/fgz/reviews/31.php
The facts: Germany's unemployment rate is at 4,5 million, when adding the quiet reserve it is more like 5 to 6 million. Trend: consistent. Black market labor has reached, with approximately 17 % of the GDP, its highest level since the Federal Republic's coming into existence. Trend: increasing. The employer's costs on a high level. Trend: persistent. Fewer German company's go public. Trend: reaching zero. In 2002, the number of insolvencies rose 10%, not only because of new insolvency policies. Trend: restrained.
Something not so, so dated then? 06-06-05
http://www.moneyandmarkets.com/euro-chaos-8650
In Germany, for instance, a recent poll showed that 56% of the population hates the euro. They want to dump it and restore their beloved German mark.
No wonder! The German economy — like France’s — is mired in one of its worst recessions since World War II. Unemployment is running at 12%. Tax receipts are plunging. GDP growth is a paltry 1%, despite massive efforts to get it going.
How about this one?
The Germans posturing for their Gold back out of our repositories in New York video is or has been removed? I watched the Video last year… in which the cameras had to be turned off inside oval office for the emergency of the Germans wanting their gold back… this was a full access day when the problem accidently was presented… http://www.msnbc.msn.com/id/30892505/#31073805
http://www.freerepublic.com/focus/f-news/2265231/posts this summation of the event is wonderful.
The German’s… being the German’s… and going protectionist have been pre-cursory events to… The German’s being the German’s…
I could totally see this going down in a few years.
First of all, Germany is getting over the postwar guilt and is acting as a normal country in its own interests. They do remember hyperinflation and don't want to repeat. The EU was constructed in cold war days with a bifurcated Germany, containing their power was less of an issue. Also Germany accepted paying for everyone else as long as they were protected from the Warsaw Pact by the Nato umbrella.
Germany's recent bilateral energy dealings with Russia is further evidence of them asserting their independence. I don't blame them one bit for not wanting to pay for lazy,profligate world champion defaulter southern Europeans.
Maybe in 10 years...
Shorter Morgan-Stanley: Monkeys might fly out of our butts. We got nothing.
....and if it they don't want that outcome they'll need Brussels to usurp power from the member nations. I highly doubt they'll cede it. The question is, did they already give it?
Faux solution meet orchastrated problem.
But if the bankers in their wisdom got everyone in Europe 'all in' when they created (or joined) the euro, some people might give them the power once the REAL crash begins.
Will U.K. ever ditch the pound to add the euro? I'm sure that idea is toast too. (probably was never on the table to begin with...just for everyone else in Europe)
The new count before pulling the rip-cord....
one, one trillion
two, one trillion
three, one trillion..............
Main in tatters, who packed a reserve?
Nobody.
Ha - too bad the EU does not have an army to enforce compliance, oh wait - you go France...
The Euro has been a boon for German manufacturing. The Germans would like to bring it to par with the USD and this also helps their relationship to the Yuan. So a couple more basket cases in the Euro zone will be great for the German economy.
Greece got into the union based on fraud. Why not throw them out, based on the fact that they hid their debt? Why not "revisit" their application?
And the other little PIIGys too. Is their union a contract or not?
Didn't you get the memo? Contracts aren't worth the paper they are written on these days... (It would be sweet justice to see that happen though.)
The whole idea of German financial strength may not be exactly what it seems. Although this Bloomberg article only deals with what are small deals in the great scheme of global finance, consider how the many mulltiples of these swaps are going to hammer the banks as they get worked out.
http://www.bloomberg.com/apps/news?pid=20601109&sid=a30KHZKX1WJo
The Germans have their own versions of financial disguises. There will be enough problems with the banks there to take up all of the "stability" funding the country has capacity to generate. The article on the proposed Argentina offer of a 60%+ haircut is how all of this stuff will workout.
http://www.bloomberg.com/apps/news?pid=20601087&sid=a5hqBb2kIcS0
Sure, I can imagine that the german population is disgusted and angry with it, as they should be. However, when the full extent of the EU problems and the German problems have boiled to the top, they had better consider well the consequences of non-cooperation.
= the US is really really concerned that they can not finance their expenses simply by printing more dollars anymore. They will do whatever it takes to kill the Euro.
Still got some deutschmarks sitting around that would come in handy this Octoberfest!! Should have some real purchasing power so I can git nice 'n crunk - and maybe the locals will be stoked to see 'em, like if we found a silver certificate ;)
I wonder sometimes if Germany and France are not seing the Euro as a tool by which to force their will on others. Kind of conquerring the continent without war, so to speak.
The would make the Merovingians proud, I guess.
The German Deutschemark II would be the world's best currency, making any euro debt easier to dispose of and making any euro-priced assets the Germans happen to fancy even cheaper to buy than they already are. It would also make Germany's tax payers happier (who have muddled along with no big wage rises and no feel-good house price bubble of their own for years now).
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