The Previously Unthinkable Becomes A Planned Event

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Wolf Richter   www.testosteronepit.com

Governments and companies around the world have been preparing for a collapse of the Eurozone—simple prudence requires them to do that. Theoretical exercises for a hypothetical scenario, they call it. But recently, these theoretical exercises have taken on practical overtones.

In early December, Swiss Finance Minister Eveline Widmer-Schlumpf told parliament that the Swiss government was preparing concrete measures to defend Switzerland against a collapse of the euro. And then, just before the Brussels summit, Nicolas Sarkozy voiced his existential concerns about the Eurozone (Sarkozy: “The Risk that the Euro Will Explode”). Large corporations are also preparing.

"Our teams work on all possible scenarios, including an exit from the Eurozone,” said Gilles Schnepp, CEO of Legrand, a French industrial company, during an interview with Les Echos on December 19. “We are doing simulations of what the exit of one or the other country would mean for our activities, balance sheet, and cash flow.”

Daimler is looking for a stabilizing force in ... China. Chairman Dieter Zetsche is offering Chinese investors, including state-owned China Investment Corporation, a 5% or 10% stake (Manager Magazin, December 20). Daimler is also building up its joint venture with Chinese partner Baic. Greater reliance on China could afford the company some protection from the travails of the Eurozone. Every major company must have some irons in the fire.

But now the collapse of the Eurozone has entered public discussion via the front pages of the largest daily newspapers in France and Germany. And increasingly, regular people are comfortable debating an issue that not long ago was completely out of the question.   

"The Explosion of the Eurozone is now possible," said today’s headline of Le Monde. The French daily, a staunch supporter of the euro, dove into details: French banks have steeped themselves in silence. "Not part of our scenarios," said Baudouin Prot, president of BNP Paribas. And Société Générale considered that issue something "that cannot be considered." The largest retailers Carrefour and Casino haven't made any announcements either, but they too will have to deal with these questions, "given the size of their supply chains in euros and dollars." According to Le Monde:

If most executives want to make believe that such an eventuality is unthinkable, in the shadows, economists of large financial institutions are simulating the effects of an implosion of the monetary union on the needs of their clients, investors, traders, and entrepreneurs.

Le Monde got specific. "Those that have funds ask us into which bank they should deposit their money," said Nikan Firoozye, an economist at Nomura in London. He co-wrote a report that explored the subtleties of a Eurozone explosion. For example, a foreign professional bought assets in euros and hedged them against euro-dollar exchange risk. What would happen to that hedge if the investment were converted to pesetas? "I don't have an answer to everything," he admitted.

The German Handelsblatt featured a long discussion today on what would happen if Germany reverted to the Deutschmark. And it advised its readers on how to prepare their finances for that event.

"A share would remain a share," it started out comfortingly, and price would be determined by supply and demand, as before. The rest could be iffy, however. Stock exchanges could be closed for a while to implement the conversion. Once trading restarts, shares would plummet, and the crash would cascade around the world.

It would be a challenge for Germany’s export-dependent companies. Their customers in Southern Europe, whose currencies would be devalued, could no longer afford German products. Revenues would collapse. Recession and large-scale unemployment would follow.

So what should German investors do? The Handelsblatt is clear: Don't load up on equities, and focus on German companies that do most of their business within Germany. Kabel Deutschland, for example. Its revenues come from German subscribers, and they will still watch TV, even if they get their Mark back. And don’t end up with stock in an Italian company at the moment when the euro converts to other currencies. Those shares would be valued in lira whose future devaluation would be immediately priced into the shares.

German Bunds would likely be converted to Deutschmarks and would be guaranteed in Deutschmarks, a safe bet, presumably. Corporate bonds would be riskier. Contracts don't include language that would allow for them to be paid back in a different currency. Perhaps a voluntary conversion would be the solution. Fly in the ointment: if Germany by law converted all euro debt of German companies into Deutschmarks, it would replace debt denominated in a softer currency with debt denominated in a harder one, which might make it impossible for companies to pay it off, and bankruptcies might ensue.

Investment in real estate, the Handelsblatt suggested, would be relatively safe because “a house will remain a house.” But values could come under pressure in a long recession. And there is always gold, physical gold ... coins, actually.

"For all those who have to deal with money in Frankfurt, the Deutsche Mark scenario is a horror." Breaking apart the ECB payment system would be tricky. And the logistics of reintroducing the various currencies would be a nightmare. From ticket vending machines to ATMs to banking computers, everything would have to be converted—a three-year process to get things to where they were before.

The fact that major newspapers advise their readers on how to deal with a Eurozone collapse suggests that the people are coming to grips with the scenario. And once a certain comfort level sets in, popular support for the many financial, political, monetary, and democratic sacrifices required to save the euro will dwindle. Which would spell the end of the euro. Meanwhile, the European Union would go on as a free-trade area, though perhaps in altered form.

Sarkozy, the only French president since World War II with two recessions under his belt, faces a tough reelection campaign. Front runner François Hollande vows to oppose the German dictate on how to save the euro. For how that election could unravel everything, read... Political Realities Threaten To Split The Eurozone.