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.


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
knukles's picture

Think PPT type shit; you know, the ECB, etc., etc., etc.....

For Christ's sakes, the EU and Euro will not make it. 
Their "leaders" are effectively bankrupting the populace trying desparately to keep some fantasy alive.  Their actions, resulting in immense social-political-economic disloctions and costs are Criminal!
Let the damned thing go and get back to some semblance of reality.

LongBalls's picture

If you are German and read ZH get this out to your fellow countrymen. You have a chance if they are considering it. LEAVE the EURO NOW! Escape the Central Banking debt currency system and start over with sound money.

Robot Traders Mom's picture

Here are the two problems. One, we have all of their physical gold and they won't be getting it back anytime soon to back a currency. Two, So much money would plow into the German Mark and they would have massive inflation due to currency strength and their exports would slow to stand still speed-kind of like what we are seeing with the Swiss right now...

trav7777's picture

gold, schmold, they can back it with Benzs.

Snidley Whipsnae's picture

Currency controls... get ready for them...coming to a currency near you.

richard in norway's picture

a strong currrency results in low inflation but screws your exporters, but god is it good to travel with a strong currency. here in norway i'm dirt poor but every time i travel to europe i can lord it over all the peasents


slow motion train wreck proceeding inexorably forward.

Hulk's picture

Tip of the Cow catchers just now touching...

Hulk's picture

Just the slighest "shit" out of the guy, just before impact!

Rogue Economist's picture

The Party is OVAH!


Mad Marv's picture

Things just keep ramping up exponentially.  I'm ready for the friggin re-set already! 

MoneyWise's picture

"Warns Of Collapse Of Banking System And Civil War "

I'm thinking how far people can actually go to make money?

What collapse? what crisis? where are you living?

In USA retail stores are f*cking packed.

I should say Biz. are booming,

that's almost right terminology.. Where you, f* outer space

aliens came from? I guess any story to make your hit counter

spin is good???..

It's not wise to make money off the sick people. :)

Doom heads! Check your local Shopping mall.. Crisis my A$$!!!

silvertrain's picture

Thats not enough for a system that needs more and more growth to survive..This monster likes to eat..

brew's picture

you'll like this better... Jim Cramer 


RT No need to panic. But no need to buy. If you have good yielders you are safe. But banks and tech will be terrible....Cyclicals, too...

DeadFred's picture

Talk about space aliens!

kahunabear's picture

Ha, yes, what better evidence is there of a productive economy than full shopping malls. We produce debt laden shoppers better than anybody!!

Prometheus418's picture

You are aware that in all the finest zombie movies, the risen dead congregate at retail establishments, right?

Everyman's picture

I can only give you one green.  You deserve many for that.  Zombie banks indeed.  "Just don't go near the damn mall and you will be OK."

Snidley Whipsnae's picture

Prom... I believe that the zombies in 'Night of the Living Dead' congregated in a farm house...

For a change of pace someone should make a vegan zombie movie.

topcallingtroll's picture

I am thinking of an asian zombie movie

Or maybe islamozombie film

Yeah what would a Hindu undead zombie crave?

Manthong's picture

A little curry liver tartare served at 98.6 degrees F mignt be a nice start.. maybe with a side of humus.

Zero Debt's picture

One retail zombie movie please, put it on my zombie bank credit card, thanks

Ned Zeppelin's picture

Checked mine, it was empty, and there are lots of vacant stores. Are you blind? Maybe you live in Connecticut. 

Bring the Gold's picture

No fucking kidding I was thinking the same thing. He must live eyeball deep amongst the parasite class.

kito's picture

@moneywise---all of a sudden the malls are an accurate gauge of an impending global default based on massive govt debt and banking liquidity issues???? 

sun tzu's picture

Didn't you know that debt defaults can't happen in Europe if the malls in America are packed?

Bring the Gold's picture

This is one of the most ignorant comments I've seen on this site. Go pitch the blue pill elsewhere shill and/or denialphillic asshole.

DosZap's picture

Money Wise,@20:26,

Where do you live in US?, I am in Texas and a well offf area,and the local malls are almost like Zombie Towns.

Only on weekends are there any cstomers where they were packed every day.

People here are buying only what they need, not wants.Like I said this one of the top 3  counties in Texas................income wise and business wise.

jules from aus's picture

Michael Stipe had an authorative piece on this scenario some time ago:

navy62802's picture

Wait, UBS admits that breaking up the EU would kill UBS? I'm in ... as long as the US can get its money back. But I doubt that's the case. Even so, I'm in because that would mean UBS wouldn't exist to steal our money in the future.

Religion Explained's picture

wtf do u mean, "... as long as the US can get its money back." Stay quiet fool.

navy62802's picture

correction - "as long as US taxpayers can get their money back ..."

Religion Explained's picture

Still sooo wrong. Your correction is again incorrect because it infers that UBS stole taxpayers money. That's what our government does, UBS prevents the theft in the first place.

Ropingdown's picture

The UBS brief is remarkable.  Consider that UBS is primarily a Swiss bank, and that Switzerland, alone among its neighbors, refused to join the EU and Euro.  Now UBS is essentially fear-mongering to try and coerce Germany to join a fiscal union and bear the cost of propping up the profligates to whom UBS has lent vastly more money than Switzerland is worth.  The stunning hypocricy of  the UBS commentary is deeply repulsive.

Bobbyrib's picture

You mean the Swiss wouldn't join a trading bloc set up by France and Germany for their countries to profit off of less economically viable countries (PIIGS). Curse them!

knukles's picture

Fear mongering.... Damned right!
They want to attract additional new meat, er, clients, from the other EU nations about to be the departed.  Playing to the olde traditional Swiss saftey, security and silence.

New meat ripe for Skullfucking!

Zero Debt's picture

Gold backing of the Swissie is going to tumble hard...

The Shootist's picture

They must save the European Union, it's for the children. Benjamin Sholom Bernanke will bear the burden of the world if he must.


Just kidding, get some real money while you can!

MoneyWise's picture

Stop lying bastards..

Cheesy Bastard's picture

But don't stop laying bastards..

blunderdog's picture

They're trying, but you just won't shut up.

CrashisOptimistic's picture

Well, looking at some lesser looked at parameters:

This moment the 10 year bond futures say 1.91% (!!!).  Behold the flight to somewhere, anywhere, not gold that isn't equities.

The 6 and 12 month paper is slightly down, as people know damned well QE3 is not truly QE because it won't be a net increase in bond buying.  Rather, the Fed will punish anyone looking for safety and force them at gunpoint out to the long end.

The Brent spread is moving towards $27 friggin dollars with Brent at $110.

The proof of the pudding will be when no one will lend Greece money, they have to drive their deficit to zero overnight, and then somehow find an oil provider to sell them oil for . . . drachmas?  When they can't get oil, that's when the Red Cross arrives with refugee biscuits.



CrashisOptimistic's picture

And it's actually deeper than this.  

You see, if Greece defaults and suffers no particular pain due to a rushing in of aid agencies, and life re-orients itself there with not a single death, then they are going to very rapidly have company in defaultville.

Only if they have mass murders and sniping of bankers and politicians will Spain, Italy, Portugal and whoever find some way not to default.

zorba THE GREEK's picture

"and it's actually deeper than this"

If that is true, which seems logical, then TPTB will make certain that Greece suffers

severely when they default.

CrashisOptimistic's picture

Yup.  And every minute of it will be on the 6 o'clock news every night.

It's a very tough read.  Do they have mass killings on the 6 o'clock news every night, or do they have everyone default.

Bicycle Repairman's picture

Will they label these killings a "civil war"?