Wed 12/7/11 9:36 AM – Collapse of Euro Would Devastate Banks, German Exports

One thing that no one is really talking about was mentioned on the CNBC web site today and that is the effect the collapse of the European Union into separate countries again would have on the stronger countries in the Eurozone and on banks.

If countries like Greece, Ireland, Portugal, Spain and Italy were to be on their own again their currencies would almost surely be valued far below what the Euro is at today, perhaps as much as 70% – 80% less. What that would do is cut the value of their bonds by that amount. Anyone holding those bonds, and European banks own a lot, would take an equivalent hit on their value. Unless there is some agreement to pay these debts in some kind of Euro-equivalent way, at maturity the country is going to pay in their own currency, not the Euro. This would mean massive losses and recapitalization of European banks. That’s a huge problem that I have not heard anyone mention before.

The southern, troubled countries with currency values much less than say Germany, France, the Netherlands and the UK would have an enormous advantage in exports. That would lead to strong export growth for them at the expense of the more responsible countries. Since the stronger countries export a lot into the rest of Europe, those countries would likely see a huge downturn in exports because their currencies are relatively uncompetitive.

Because of these two costs and there would be others, the cost of breaking up the Eurozone is extremely high. The pressure is really on. But, the plan that Merkel and Sarkozy have agreed to, that would put sanctions in place for countries that let annual deficits get over 3% of their GDP is really not so much different from what the original treaties laid out and that has not worked at all. Yes, sanctions would be automatic but waivers could be voted in by a 2/3 majority and in a crisis this is not unlikely. This whole thing is really a Gordian knot.