Will the euro survive until Christmas? It is far from certain. It is even more uncertain, even unlikely, if it will survive until the Christmas after this, 2012. Investors are gearing up for a partial or complete collapse of the eurozone, the group of European nations that use the euro as their common currency.
Last week, Andrew Bailey, a director of the British Financial Services Authority and the former Chief Cashier at the Bank of England, whose signature appears on all British banknotes issued between 2004 and 2011, told a banking conference in London that British banks need to be prepared for a disorderly break-up of the eurozone.
The Wall Street Journal wrote that banks are stress-testing their systems to be sure they can cope with the euro breaking up. The lawyers are being called in. The Japanese Nomura Bank advised investors to check the fine print on their euro-denominated bonds, to ascertain what would happen with them if the euro collapsed. Would they be converted into a revived local currency or remain denominated in euros, provided the euro still exists? A Barclays Capital survey shows that nearly 56% of investors expect at least one country to leave the euro.
A full-scale crisis of confidence and liquidity has affected the eurozone. Even Germany, the strongest and biggest economy in Europe, is not immune to the eurozone debt crisis. Last week Germany succeeded in raising only €3.9 billion from a €6 billion ($8.1 billion) auction of 10-year bonds. The shocked German authorities blamed the unexpected lack of investor interest for German sovereign bonds on "the extraordinarily nervous market environment."
Some economists said the weak demand was caused by the low interest rate of 1.98% offered by Germany. But others suggested a much more worrisome explanation: investors simply no longer trust any eurozone government bonds – not even Germany's. As the euro crisis deepens and widens, and as one domino after another falls, many fear that even Germany, the last domino, will inevitably fall. A third group of economists warned that investors no longer have enough capital available to invest. During the past year, the losses in the stock markets have been devastating. An enormous amount of money has evaporated.
So far, all solutions proposed by Europe's politicians to halt the euro collapse have exacerbated the crisis. The governments of Greece and Italy have been replaced by unelected technocratic apparatchiks. The spending cuts which are being imposed on countries such as Greece and Portugal are deflationary. Economic growth in the stronger northern countries of the eurozone has come to a halt. German export to the weaker eurozone countries in the south has collapsed: the economy in the weaker countries is shrinking, and consumer demand has entirely dried up.
The most likely scenario is that Greece will be forced out of the euro. It might, however already be too late for that. Contagion has already spread too far. The exit of Greece, Portugal and Cyprus would probably not be enough to restore confidence in the euro anymore; while forcing Italy and Spain out of the euro is an option that France will not consider as it will have devastating consequences for French banks. Hence, some Germans suggest that perhaps Germany should leave in order to save itself.
Realizing that even Germany might go down as a result of the debt burden of the southern eurozone countries, the option that Germany cut itself loose from the eurozone and reintroduce the D-mark is no longer taboo. Dirk Meyer, an economy professor of the Helmut Schmidt University in Hamburg, calculated that leaving the euro would cost Germany over €200 billion or approximately 10% of its GDP. The cost would, indeed, be gigantic.
According to Prof. Meyer's calculations, saving the euro will cost Germany an annual €60 billion. However, as the €200 billion to be paid in the event of Germany returning to the D-mark is a non-recurring expense, it needs to be paid only once. Given that the €60 billion needed to save the euro would have to be paid each year, Meyer argues that Germany will benefit from leaving the euro. From the fourth year onwards, the cost of leaving the euro would be more advantageous than remaining in the euro. With the D-mark, Germany's economy could begin to grow again, unburdened by the debts of weak eurozone countries.
Last Sunday, Welt am Sonntag published figures by the Munich economic Ifo Institute, revealing that Germany alone risks losing up to €560 billion if Greece, Ireland, Portugal, Spain and Italy are to be bailed out by their eurozone partners. While no one doubts that the cost of leaving the euro will be enormous, more and more Germans are beginning to doubt whether the benefits of staying outweigh the cost of leaving. Perhaps the pain will be worth it.
Foreign correspondents covering European Union (EU) affairs from Brussels are cancelling their Christmas holidays. If one or more countries decide to the leave the eurozone, the bank holidays following Christmas might be the ideal moment to do so. It is clear that something has to happen soon. If not, the entire eurozone may collapse.
Whatever happens, it will have worldwide repercussions. Germany is the fifth largest economy in the world, after the U.S., China, Japan and India, and, taken as a whole, the economy of the European Union is the world's largest.
The eurocrisis has already affected Eastern Europe, since eurozone banks and investors are withdrawing their money from Eastern Europe. The European Central Bank calculates that in the past twelve months the eurozone private sector withdrew €335 billion ($445 billion) from Eastern Europe – over €300 billion more than in the preceding twelve months. Meanwhile, American banks and investors have begun to sell their investments in the eurozone. Roughly the same amount of money that is currently flowing back to the eurozone from the east, is flowing out of the eurozone to the U.S. and elsewhere.
Between 2006 and 2011, European banks (notably the French) borrowed around 50% of their total lending from U.S. money markets. Eurozone banks, however, also hold huge American assets, amounting to around $3 trillion – a large sum compared to the entire U.S. commercial banking system, which holds around $10 trillion of U.S. assets.
What is happening in the eurozone will affect the world. It is not just the political fate of French President Nicolas Sarkozy, who is running for reelection next year, that might be decided by the euro debacle, but also that of President Obama.