Bring Out Your Dead - UBS Quantifies Costs Of Euro Break Up, Warns Of Collapse Of Banking System And Civil War

Tyler Durden's picture

Any time a major bank releases a report saying a given course of action is too costly, too prohibitive, too blonde, or simply too impossible, it is nearly guaranteed that that is precisely the course of action about to be undertaken. Which is why all non-euro skeptics are advised to shield their eyes and look away from the just released report by UBS (of surging 3 Month USD Libor rate fame) titled "Euro Break Up - The Consequences." UBS conveniently sets up the straw man as follows: "Under the current structure and with the current membership, the Euro does not work. Either the current structure will have to change, or the current membership will have to change." So far so good. Yet where it gets scary is when UBS quantifies the actual opportunity cost to one or more countries leaving the Euro. Notably Germany. "Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. " It also would mean the end of UBS, but we digress. Where it gets even more scary is when UBS, like many other banks to come, succumbs to the Mutual Assured Destruction trope made so popular by ole' Hank Paulson : "The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s “soft power” influence internationally would cease (as the concept of “Europe” as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war." So you see: save the euro for the children, so we can avoid all out war (and UBS can continue to exist). The scariest thing, however, by far, is that for this report to have been issued, it means that Germany is now actively considering dumping the euro.

Executive summary:

Fiscal confederation, not break-up


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. Countries can not be expelled, but sovereign states could choose to secede. However, popular discussion of the break-up option considerably underestimates the consequences of such a move. 


The economic cost (part 1)


The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around EUR9,500 to EUR11,500 per person in the exiting country during the first year. That cost would then probably amount to EUR3,000 to EUR4,000 per person per year over subsequent years. That equates to a range of 40% to 50% of GDP in the first year. 


The economic cost (part 2)


Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over EUR1,000 per person, in a single hit. 


The political cost


The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s “soft power” influence internationally would cease (as the concept of “Europe” as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.

A little more on that particularly troubling last point:

Do monetary unions break up without civil wars?


The break-up of a monetary union is a very rare event. Moreover the break-up of a monetary union with a fiat currency system (ie, paper currency) is extremely unusual. Fixed exchange rate schemes break up all the time. Monetary unions that relied on specie payments did fragment – the Latin Monetary Union of the 19th century fragmented several times – but should be thought of as more of a fixed exchange rate adjustment. Countries went on and off the gold or silver or bimetal standards, and in doing so made or broke ties with other countries’ currencies.


If we consider fiat currency monetary union fragmentation, it is fair to say that the economic circumstances that create a climate for a break-up and the economic consequences that follow from a break-up are very severe indeed. It takes enormous stress for a government to get to the point where it considers abandoning the lex monetae of a country. The disruption that would follow such a move is also going to be extreme. The costs are high – whether it is a strong or a weak country leaving – in purely monetary terms. When the unemployment consequences are factored in, it is virtually impossible to consider a break-up scenario without some serious social consequences.


With this degree of social dislocation, the historical parallels are unappealing. Past instances of monetary union break-ups have tended to produce one of two results. Either there was a more authoritarian government response to contain or repress the social disorder (a scenario that tended to require a change from democratic to authoritarian or military government), or alternatively, the social disorder worked with existing fault lines in society to divide the country, spilling over into civil war. These are not inevitable conclusions, but indicate that monetary union break-up is not something that can be treated as a casual issue of exchange rate policy.


Even with a paucity of case studies, what evidence we have does lend credence to the political cost argument. Clearly, not all parts of a fracturing monetary union necessarily collapse into chaos. The point is not that everyone suffers, but that some part of the former monetary union is highly likely to suffer.


The fracturing of the Czech and Slovak monetary union in 1993 led to an immediate sealing of the border, capital controls and limits on bank withdrawals. This was not so much secession as destruction and substitution (the Czechoslovak currency ceased to exist entirely). Although the Czech Republic that emerged from the crisis was considered to be a free country (using the Freedom House definition), with political rights improving relative to Czechoslovakia (also considered to be a free country), Slovakia saw a deterioration in the assessment of its political rights and civil liberties, and was designated “partially free” (again, using Freedom House criteria).


Similarly the break-up of the Soviet Union saw authoritarian regimes in the resulting states. Of course, this was not a change from the previous status quo, but that is not the point. The question is not how a liberal democracy develops, but whether a liberal democracy could withstand the social turmoil that surrounds a monetary union fracturing. We lack evidence to support the idea that it could.


Even the US monetary union break-up in 1932-33 was accompanied by something close to authoritarianism. Roosevelt’s inauguration was described by a contemporary journalist as being conducted in “a beleaguered capital in wartime”, with machine guns covering the Mall. State militia were called out to deal with the reactions of local populations, unhappy at what had happened to the monetary union (and specifically their access to their banks).


Older examples are less helpful, as they tend to be more akin to fixed exchange rate regimes under a gold standard or some other international monetary arrangement. Nevertheless, the Irish separation from the UK, or the convulsions of the Latin Monetary Union in Europe (particularly around the Franco-Prussian war in 1870 and its aftermath) saw monetary unions fragment with varying degrees of violence in some parts of the union.


Writing in 1997, the Harvard economist Martin Feldstein offered a view that seems to be somewhat chillingly precognitive. He said “Uniform monetary policy and inflexible exchange rates will create conflicts whenever cyclical conditions differ among the member countries... Although a sovereign country... could in principle withdraw from the EMU, the potential trade sanctions and other pressures on such a country are likely to make membership in the EMU irreversible unless there is widespread economic dislocation in Europe or, more generally, a collapse of the peaceful coexistence within Europe.” (emphasis added).

As for what happens if UBS, and the Euro Unionists lose the fight for the euro:

Our base case for the Euro is that the monetary union will hold together, with some kind of fiscal confederation (providing automatic stabilisers to economies, not transfers to governments). This is how the US monetary union was resurrected in the 1930s. It is how the UK monetary union, and indeed the German monetary union, have held together.


But what if the disaster scenario happens? How can investors invest if they believe in a break-up, however low the probability? The simple answer is that they cannot. Investing for a break-up scenario has not guaranteed winners within the Euro area. The growth consequences are awful in any break-up scenario. The risk of civil disorder questions the rule of law, and as such basic issues such as property rights. Even those countries that avoid internal strife and divisions will likely have to use administrative controls to avoid extreme positions in their markets.


The only way to hedge against a Euro break-up scenario is to own no Euro assets at all.

Alas, this will be the final outcome. Unfortunately trillions more in taxpayer capital will be lost before we get there.

In the meantime, enjoy as UBS just unwittingly announced the final countdown for the EUR.


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Caviar Emptor's picture

Warns Of Collapse Of Banking System And Civil War

....revenge of the zombie banks!! It's a perfect C-budget sci-fi movie. They eat wallets, credit cards and bank accounts! Oh my

brew's picture

it's all coming together quite nicely...

Michael's picture

I love it when my plans come together.

I've been taunting the Wall Street whiz kids for decades so they would continue blowing up our monetary system despite the bubble years, and they performed admirably for me.

Complete and total worldwide economic annihilation was the only way to achieve my goal. Sorry.

jekyll island's picture

Couldn't you just have invested in a 401k plan? 

Crisismode's picture

Don't give me this shit here.



If things are so bad, why is Gold at a WIMPY $1903??


Why is gold not at $2500+??


If the Shit is Hitting The Fan, Why is gold not $4900., and Silver not $350.???



WTF are you waiting for???

Crisismode's picture



Gold and Silver price are BEING MANIPULATED DOWN!




Gold and silver can rise above all this bullshit IF THEY HAVE THE BALLS!!!



tickhound's picture

this one's still only mostly dead

Arthur Two Sheds Jackson's picture

Europe:What was it?

The Grim Reaper:The Salmon Mousse.......

TruthInSunshine's picture

Who will play the roles of the European versions of Hank 'Tank in the Streets' Paulson, Ben 'No Banker Haircuts' Bernanke & Timmmay 'I Want To Be A Player - Can I? Huh? Please' Geithner?

Ahmeexnal's picture

NL will be the first to abort the euro and go back to the Gulden.

eureka's picture

Nobody is going to leave the EUR.

UBS are the scumbags who ripped of US IRS.

Fuck UBS and fuck investors/gamblers/banksters everywhere.

Germany will let their own banks take a haircut. German citizens will soak up billions more of ever more austerity strikken and thus cheaper Greek coastal real estate (Germans don't have much coastline at home).

Germany will keep its manufacturing engine pumping quality goods to both their EU/EUR partners and China.

US markets will collapse within the next nine months. Watch carefully - as the EU distraction game comes to an end and further foreign financial scapegoat stories expire.

Ghordius's picture

Agree, first the EUR dies (and this could take some decades) before any member leaves.

Agree, anything a TBTF says has an agenda. My suspicion is that UBS needs a stronger dollar.

Disagree, "US market collapse" is a big word. Ben will print (much) more.

the tower's picture

You obviously don't know anything about The Netherlands. 75% of export goes to EU countries. By leaving the Euro they will damage their economy beyond repair. They will be the LAST to leave.

Tompooz's picture

No way. At most they will make sure to be part of a new and smaller core-euro zone together with Germany, Austria, Luxembourg (Belgium is the question- Brussels sits right on top of the fault-line.) and other budget-balancers. 

You have heard what Zalm said about the consequences of leaving.

Hope your old guilders and rijksdaalders are all of the silver variety. :-)


Finger firmly in dike's picture

Where can i sign? Would be great but it is probably too late.


They still have (or perhaps now had) the 'gulden' in Bonaire. What a wonderful experience to use that again but presume they will have to change seeing they are now a dutch municipality.

spiral_eyes's picture

well the thing that got ron paul into politics was nixon abolishing the gold standard. and it looks he was basically correct that this would ruin america.

it took 40+ years to come to fruition. let's hope the crowning achievement of ron paul's political career is being elected president in 2012. 

tiger7905's picture

Don Coxe Update, focus on gold equities in the Q+A

hivekiller's picture

I hate to tell you but if Ron Paul is elected President either he will be assassinated or America will be attacked as a 'terrorist' nation. Think Libya. Think JFK. Think Andrew Jackson. Get the picture? I'm not saying I won't vote for Paul but if we are serious about taking back our country and our rights, we have to shed a lot of blue blood.

iDealMeat's picture

I junked you.. All you have to do is cut your consumption in half.. There is nothing to "take back"..  Its all gone, or its garbage..  Vote however you want, or, don't vote. same thing.. Cut your consumption in half and the system resets. Prepare, then do your part to grow it all back organically.. Your lifestyle doesn't change.

hivekiller's picture

The Obamanomy has already cut my consumption in half and guess what? He's still there.

Joy on Maui's picture

I did this some time ago, not for ideological but for purely ecological and ethical reasons.   I just now realize that it is the most profound political statement we can make.   Thank you for pointing that out, and please, let's spread the word.  A dollar spent is a vote cast, after all.

Cathartes Aura's picture

living with less, desiring less, needing less - freedom.

it's a tough call for consumers to learn how to be citizens again, I'm not holding my breath tho'

Mauibrad's picture

Hope they do it.  Let's get this show on the road.  Pull the plug on the Euro.

DaBernank's picture

But you all need to just read (and believe) high-priest FOFOA to understand why the ECB is the world's most perfect banking mechanism, all will be well. </sarc>

Ganja Jane's picture

You forgot good ol' Abe Lincoln. Give the Greenback some love...

I was gonna write the same. For that reason, Dr.Paul has a target on him.

Robot Traders Mom's picture

@midlife crisis troll-Your mom goes to college.

Reptil's picture

The reality has not yet hit home over here. Conditioning that all's well is in effect, that managing consensus will lead to continuation of the ponzi, and hollidays are just over. Do not expect the average trader or investor to be well informed or have the mindset that goes with the screen name "Crisismode".

Give it some time... and then add true scarcity of the physical, and you'll have a perfect storm with no ceiling.

Freddie's picture

Also just cause gold "ain't" at $2500 does not mean it cannot get there is a few days or even a day.

As far as a war with the euro breaking up...   Czechoslovakia had a very civilized break up where the Czech Repub went it's way and Slovakia went it's way.  It helps that both countries are pretty level headed and civilized.   They nevr should have let Greece, Portugal and maybe Spain in the EU.  They never should have had a common currency.

Almost from the day the euro was launched - most Germans and Italians knew it was a big mistake.

Snidley Whipsnae's picture

Freddie... Lest we not forget, It was goldman sucks that helped Greece doctor their books to make the deficit look smaller than it was... GS designed SIVs just for Greece to hide debt...

The terrorists of 9-11 hit the wrong buildings...

molecool's picture

This German hated the very concept from day one. And here I am being proven right - once again. Bringing back the Deutsche Mark would be a major step forward - the sooner we abandon this failed experiment the better (and the cheaper for us Germans).

the tower's picture

You may have hated it but it brought you wealth the past 10 years. Wealth you could not have gained without the Euro. The problem is NOT the Euro, the problem is the international financial system of corrupt and greedy banks and politicians.


They will stay after the Euro goes and will continue their games, so fight the cause, not the side-effects.

PY-129-20's picture

It brought wealth to German companies, but not to German citizens. Not all of it had to do with the Euro, but I am just saying that the ordinary German lost wealth in the past 10 years. (lowest income lost a staggering 22 % since 2001; only people earning more than 4000 EUR/month got a little plus; rest lost wealth).

When I was a kid the people in my country could be considered wealthy. That is not the case anymore. Sadly.

Léonard's picture

Again, the end of the Euro will not mean the end of the European unity.

If there's going to be a war in Europe, it will be against 3 specific targets :

- the anglo-american domination

- the financial and banking system

- the afro-muslim colonization

Europeans will not fight against each others. I know some on the other side of the Atlantic and the Mediterranean Sea would love to see that happen, but it won't.

Optimusprime's picture

I hope you're right about the war aims.  Just don't let the anglo-american-Jewish cabal distract you into fighting each other again.

Zero Debt's picture

Gold has discount window not make you happy?

candyman's picture

patience young grasshopper, everyone not out of the theater yet, the last scene has not been shown yet.

JohnG's picture

Won't be a long wait now.

MFL8240's picture

I guess its fair to say that you are long equities, own no gold and believe in this and the European goverments??

lix333's picture

If shit hits the fan gold and silver will be the first thing people and central banks will sell. What else does a liquidity crunch mean?

Snidley Whipsnae's picture

Not... What you described happened in 2008 because of a liquidity shortage...

The situation is not the same now... Fiat has been pouring into gold in a flight to safety... Otherwise the spot price would have been moving with securities as in the past few years... Gold is now decoupling from all other asset classes...

Pull up the charts and compare for yourself.

kito's picture

@crisis mode

here is your answer, compliments of chris martenson:


Using an example drawn from a magnificent paper by Dr. Albert Bartlett, let me illustrate the power of compounding for you.

Suppose I had a magic eye dropper and I placed a single drop of water in the middle of your left hand. The magic part is that this drop of water is going to double in size every minute.

At first nothing seems to be happening, but by the end of a minute, that tiny drop is now the size of two tiny drops.

After another minute, you now have a little pool of water that is slightly smaller in diameter than a dime sitting in your hand.

After six minutes, you have a blob of water that would fill a thimble.

Now suppose we take our magic eye dropper to Fenway Park, and, right at 12:00 p.m. in the afternoon, we place a magic drop way down there on the pitcher’s mound.

To make this really interesting, suppose that the park is watertight and that you are handcuffed to one of the very highest bleacher seats.

My question to you is, “How long do you have to escape from the handcuffs?” When would it be completely filled? In days? Weeks? Months? Years? How long would that take?

I’ll give you a few seconds to think about it.

The answer is, you have until 12:49 on that same day to figure out how you are going to get out of those handcuffs. In less than 50 minutes, our modest little drop of water has managed to completely fill Fenway Park.

Now let me ask you this – at what time of the day would Fenway Park still be 93% empty space, and how many of you would realize the severity of your predicament?

Any guesses? The answer is 12:45. If you were squirming in your bleacher seat waiting for help to arrive, by the time the field is covered with less than 5 feet of water, you would now have less than 4 minutes left to get free.