Building on yesterday's discussion [6] of the lack of an integrated banking system and credible lender of last resort in Europe, UBS appears to have gone thermonuclear this morning. Their lengthy article 'What If Greece Goes?' outlines the contagion risk from an 'orderly' exit as markets, international trading companies, and bank depositors will all anticipate the consequences likely resulting in economic disorder. Their remains a great deal of complacency about the ability of firewalls to prevent this - but as they note - should bank runs begin, even a pan-European deposit guarantee scheme will not stop rational depositors extending bank runs instead of gambling on the probability of policy-maker actions. Laying out Greece's options (renegotiate austerity or default), UBS summarizes the situation more profoundly: "Integrate Or Die" as without a Euro confederation (in their eyes), continental Europe will cry 'havoc' once again.
UBS - What If Greece Goes
The flaw in the Euro
The Euro at once embodies too little and too much government. The single currency lacks many of the institutions generally assumed to be necessary in a functioning monetary union. At the same time, those institutions that do exist are structured in a particularly rigid manner, and do not exhibit the ability to adapt that would allow the changing circumstances of the Euro crisis to be managed.
Why an orderly exit becomes disorderly
We believe that Greece remains in the Euro, as the costs of departure are excessive to both Greece and the Euro area. If Greece even considers making an exit of the Euro, markets, international trading companies and bank depositors will all anticipate the consequences. This anticipation of exit would likely result in economic disorder. The anticipation, and not the act of leaving, will in all probability lead to a cessation of international trade in the conventional sense, the inability of the government to raise any finance in the markets, and bank runs.
The contagion risk
In the event of a Greek exit, contagion risks clearly exist. There seems to be a great deal of official complacency about the ability of firewalls to prevent this. The risk lies in the contagion of bank runs. Bank runs, if they occur, will likely arise because of existential risks about the Euro, rather than solvency or liquidity risks about banking systems. If this does occur, then pan Euro deposit guarantee schemes (however worthy and desirable) are unlikely to provide a remedy. The possibility of other economies joining Greece in a disorderly departure from the Euro must be assumed to be very high – and it is this risk that suggests rational policy-makers would not wish to gamble on the probabilities.
Greece’s options
Greece’s options from the current standpoint would appear to resolve into some careful renegotiation of the austerity plans (and potentially restructuring the current debt again), or defaulting with an effective repudiation of the debt. There is plenty of precedent for defaulting inside a monetary union of course, so exit should not be assumed to be automatic. A default would require a recapitalised banking system (that is currently in progress) and a “forced loan” approach to financing the primary budget deficit.
A Maastricht for modern times
If the Euro’s existential crisis continues to grow, steps will be required to prevent the contagion effects. One option may be to propose a modern Maastricht Treaty. Just as the original Maastricht set out a timetable to achieve monetary union, so a modern Maastricht could lay out the necessary steps to correct the dysfunctional monetary union that now exists. A credible plan of action that commits to the continued existence of the supposedly irrevocable monetary union could reduce the risk of politicians being overpowered by the centrifugal forces in the Euro area.
Integrate or die?
The Euro area faces some tough decisions. Either there is more Europe – integration within the Euro area and a subsuming of sovereignty into a commonwealth of some description. The alternative is a disorderly break-up. An orderly break-up is simply not an option, because to embark on an orderly break-up is to invite a disorderly break-up in anticipation of the end-game. Either we have a Euro confederation and a commitment to the integrity of the union of seventeen countries, or once again continental Europe will cry “havoc”.