On a day when data confirms Spanish bad loans creeping up to recent highs and deposits continuing to stream out of the periphery, Boston Consulting Group has released an excellent treatise on the "What Next? Where Next?" perspective of the impact of collateral damage in and out of the Eurozone. The critical questions for most market watchers and prognosticators remain, how likely is an exit, and what would be the implications for 'leaver' and 'left behind'? BCG offers an at-a-glance chart of the economic, social, and market expectations for the ins-and-outs and notes, in less-than-Deutsche-Bank-like mutually assured destruction language, the cost of leaving the Euro varying from EUR3,500 to 11,500 depending on weak or strong exiting country per person per year. No matter what, an exit would impact the world economy considerably and BCG strongly suggests corporate management consider a Euro-zone breakup as a possible scenario for next year, along with a muddle-through, Japanese deflation-like evolution, and significant inflation possibilities.
For some commentators, it is not a question of whether the euro zone will break up but of how and when it will break up. There is undoubtedly an increased risk of at least some (potentially disorderly) fracture in the euro zone. And some governments are rumored to be preparing just in case - by, for example, securing sufficient capacity to print new supplies of money. Not surprisingly, we have engaged with many clients to discuss this scenario and prepare for it. A country leaving the euro zone would need to do the following:
- Announce and immediately impose capital controls
- Impose immediate trade controls (because companies would otherwise falsify imports in order to get their money out)
- Impose immediate border controls (to prevent a flight of cash)
- Implement a bank holiday (to stop citizens from withdrawing their money and running before the devaluation) and - although this is somewhat hard to imagine - stamp every euro note in the country, converting it back to the national currency.
- Announce a new exchange rate (presumably not floating at the beginning, given capital and exchange controls) so that trade could continue.
- Decide how to deal with existing outstanding euro-denominated debt, which would probably entail a major government and private-sector debt restructuring (that is, default). This might be easier in the case of government debt, which tends to be governed by domestic law, in contrast to the debt of major corporations, which normally governed by UK law (but we would assume enactment of laws declaring a haircut here, as well).
- Recapitalize the (insolvent) banks to make up for losses from defaults
- Determine what to do with the non-bank financial sector, the stock and bond markets, and every company account and commercial contract in the country.
Any break up would lead to significant turbulence in financial markets - just think about the number of CDS outstanding - and a worldwide recession. The OECD has warned that a breakup of the euro zone would lead to 'massive wealth destruction, bankruptcies, and a collapse in confidence in European integration and cooperation,' leading to 'a deep depression in both the existing and remaining euro area countries as well as in the world economy.' The chart above describes a breakup scenario and its potential implications.