How the euro might collapse

By Felix Salmon
May 20, 2010
fantasia this morning on Radio 4 in the UK; if you prefer text to audio, here you go. The idea was to give an idea of one way in which the euro might fall apart, but I had no idea, when I recorded it, that markets would plunge again today.


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I had a little three-minute fantasia this morning on Radio 4 in the UK; if you prefer text to audio, here you go. The idea was to give an idea of one way in which the euro might fall apart, but I had no idea, when I recorded it, that markets would plunge again today.

August 18, 2010:

Markets around the world plunged on Wednesday, after Spain announced that the cost of bailing out its beleaguered mortgage lenders would amount to more than 250 billion euros. The country was immediately downgraded by both Standard & Poor’s and Moody’s, triggering fears of default or devaluation in both Spain and Portugal. Stocks fall by more than 5% in all major markets, including the US.

August 19, 2010:

Chancellor Angela Merkel of Germany, in an unprecedented joint public appearance with Jean-Claude Trichet, the head of the European Central Bank, railed against “speculators and hedge funds” who were damaging European unity and threatening the viability of the common currency. She said that Europe would provide up to 500 billion euros in support of Spain, Portugal, and Greece, to help them bail out their banks during a period when investors have simply stopped lending them any new money.

August 22, 2010:

In the largest set of coordinated demonstrations since the run-up to the war in Iraq, angry voters and opposition parties across Europe came out in their millions, protesting the hundreds of billions of dollars being spent on southern European countries, and the painful austerity measures being demanded of Greece, Spain, and Portugal by the IMF.

Opinion polls show that an overwhelming majority of Eurozone members oppose the current bailout plans, both in northern European countries like Germany, which don’t want to see their money spent abroad, and in southern European countries like Greece and Spain, which refuse to be told how to run their countries by Brussels bureaucrats and the IMF.

The riot photos from Greece are becoming depressingly familiar, but now we’re seeing riots across Germany, too.

August 23, 2010:

As markets continued to plunge around the world today on civil unrest across Europe, governing coalitions across the continent broke apart, with no parties seeing any political upside in supporting the most unpopular policy that has ever been implemented in European history. Even Angela Merkel started backtracking from her earlier statements, saying that no democracy could unilaterally act against its citizens’ wishes.

August 24, 2010:

A solution, of sorts, was found to the European crisis today, when the governments of Greece, Spain, Portugal and Italy announced that they would no longer accept EU or IMF funds as part of the bailout program, and would solve their problems on their own. The joint statement was taken by markets as tantamount to default, since none of the four countries has access to the liquidity needed to roll over their debts.

August 25, 2010::

Greece has announced a debt restructuring that will push back the maturity of its bonds by three years.

It will swap existing debt for new bonds denominated in New Drachmas, which the Greek government is introducing at a 1-to-1 exchange rate but which are already trading in the “grey market” at just 50 euro cents each.

September 13, 2010:

Markets were shocked once again today as France joined, at the last minute, the joint restructuring offer from Italy, Spain, and Portugal. All four countries are offering to swap their old euro-denominated debt for new obligations denominated in a currency they’re calling “neuros”. Other eurozone countries have indicated that they, too, will leave the euro for the neuro, cutting their debt at a stroke. In the grey market, the neuro is already trading at 75 euro cents, while the new drachma is holding steady at 45 euro cents.

Today was the last day of the euro as we knew it for a decade: Europe is returning to a system of multiple floating currencies. And that means that political ties are much weaker, too. With the death of the euro, the future of the European Union itself looks very uncertain.

This is not a prediction, it’s just one way of many in which things could go wrong. There’s always a worst-case scenario. And although I didn’t have time to spell things out here, this really is a worst-case scenario, and would cause legal chaos with respect to the redenomination of assets and liabilities in what might be called the neurozone.

Which means that questions like this one, which I got via email this morning, are simply unanswerable:

What happens to the euros which I have in my travel wallet (or under the mattress or where ever) if the euro splits into various neuros? More importantly, what happens to euros held by a British bank? Answer needed!

Most likely, in this kind of a scenario, the euros would transform themselves into the currency of whatever country they’re on deposit in. You can see where the flight-to-quality trade comes from: cash flows away from euro-periphery banks and into German banks, and away from euros and into dollars, lest it end up forcibly converted into something else. Physical euros should be pretty safe: you could probably convert them into neuros at an advantageous exchange rate, assuming that it’s the weaker countries which leave the eurozone, rather than Germany and a few others deciding that they’re going to create a smaller, stronger, super-euro.

Returning back to reality, the euro itself could still fall further, especially if questions over its long-term survival continue to be raised. And all this uncertainty is bad for assets generally around the world. Expect lots more volatility going forwards.

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