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Monday, 26 September 2011

Will the Euro implode? Five possible scenario’s and their outcomes.

Last Friday, September 23 was a typical day at the office:

·        Greece is declared a possible bankruptcy candidate by the new chairman of the Dutch national Bank DNB, Klaas Knot.
·        Dutch state wants to receive €11.5bln in extra loans in the remainder of 2011.
·        Eight Greek banks have been downgraded by Moody’s
·        7 Spanish banks are in desperate need of extra capital to maintain their 5% capital buffer.
·        Europe already supported European banks with €420bln since the crisis started in 2008.

The weekend afterwards was not much better: headlines were shouting that Greece was on its way to default and everybody would already have accepted it.

The IMF failed, the G20 failed and especially Europe failed in finding a solution for the Greek problem, that grew from a little raincloud in 2009 to a tropical thunderstorm in 2011.

It seemed almost too late to take care of the Greeks. Instead, it was rather time to bail-out the French and German banks with their extensive exposure to Greek sovereigns and other loans to Greek banks. 

Therefore, the time seems right for some serious Euro-bashing on the financial markets and I’m sure that will happen in the coming weeks.

But today I would like to look at things from a different perspective: What are the alternatives for this darn Euro?! And are there any alternatives, anyway?

Let’s find out, by taking the five most probable scenarios and putting them to the test.

The scenarios: 

  1. Everything stays as is…

  2. Greece is allowed to make a haircut on outstanding debt, but stays in Euro…

  3. One or more countries leave Euro and return to old currencies

  4. Euro is split up in two or three baby-euro’s: Northern Euro, Central Euro and Southern Euro

  5. The Euro will implode and all members will return to their old currency’s.

Scenario 1:Everything stays as is…

Description: The Euro-zone, IMF and G20 continue their attempts to solve the Greek problem by handing over increasingly large sums of loans, while trying to force vast cutbacks on the Greek population.

Probability: In a normal world, this option would be an absolute no-go area. But one should never underestimate the sheer stupidity that forces the Euro-zone to maintain following the path of maximum frustration (thanks Toddo of for this beautiful proverb).

The discussion in the North-Western European countries is still not about solving the Greek problem before it demolishes the Euro-zone. The tone of voice of the politicians in these countries (i.e. Netherlands, Finland and Germany) is rather about punishing the Greeks for their irresponsible behaviour, installing a Euro commission for budget watching and keeping the EFSF at the current level.

·        It seems the cheapest solution: it is much cheaper to put a few bucks in the EFSF / EFSM and the ESM emergency funds than to accept a haircut.
·        In this solution, the large European banks don´t have to worry on the value of their investments. Greece ´will pay back all loans´.
·        The Euro will remain intact.

·        Nothing is solved really. The Greek drama continues from loan-tranche to loan-tranche and at every new tranche there will be renewed stress and panic under the members of the European Union and on the financial markets.
·        The problems will become bigger and bigger. All parties – countries and banks – with exposure to Greece in any form will be suspicious. Not only countries like Spain, Portugal and Italy will remain in the danger zone as long as the Greek drama is not solved, but also banks like BNP Paribas, Credit Agricole  and Société Générale

Final outcome
In the end, something´s got to give. And that something is Greece… and Spain (?), Portugal (?), Italy (?) and the previously mentioned banks(?). Nobody knows. But one thing is sure: this is not a sustainable path.

Scenario 2: Greece is allowed to make a haircut on its outstanding debt, but stays in the Euro…

Probability: If the Euro-zone can leave the path of maximum frustration, this is the most likely scenario. This scenario prevents Greece from being kicked out of the Euro-zone and gives Greece a second chance to change its habits, after a few years in the penalty box. In the meantime the country gets the proper ´punishment´ by having little to no access to the normal financial markets, but gets on the other hand a chance to clean their slate and start all over, hopefully helped by the other countries of the Euro-zone.

·        When any solution towards Greece is sustainable, it is this one. It will be a relief for Greece to be freed of the debt millstone. The country can start rebuilding its economy and financial system.
·        The country remains in the Euro and continues to keep access to the European export markets.
·        It might be the cheapest solution for the Euro-zone after all. Instead of spreading the pain over numerous occasions, the pain is felt as a heavy blow after the default and then it is over.
·        It is a clear signal towards the Greek population: it is your country that is bankrupted and it is your attitude that should change to regain access to the financial markets again.

·        Initially, this situation might lead to chaos and mayhem in the larger cities of Greece and to increased capital flight of the wealthy Greeks to other country.
·        The large European banks, insurers and pension funds and the ECB will suffer some serious losses. Some banks will need to be bailed-out and some smaller banks might default: the Lehman brothers scenario.
·        There is a risk of contagion, as other Southern countries in the Euro-zone might see this as the solution for their problems. In my opinion, however, this chance is not much bigger than in scenario 1.

Final outcome
After a few years, Greece can return to the financial markets. Just like Argentina did after surviving its default. It will not be the end of the world and also not the end of the Euro.

Kees de Kort, macro-economist at the small Dutch bank AFS Vermogensbeheer ( and by far the smartest analyst that I know in The Netherlands, says this about it (translated to English): ´there is absolutely no reason why a country after defaulting should leave the Euro-zone.

In case of Greece, an agreement can be made about what percentage of the outstanding debt will be written-off and then the consequences will be for the various lenders. Such an agreement can of course only be made, when there are rock-solid agreements on drastic reforms in Greece to prevent a reprise of such events. This is nasty for the people involved, but it would not become worse than this´. I totally agree with Kees de Kort and have nothing to add to this.

Scenario 3: One or more countries leave the Euro and return to their old currencies.

Probability: This is only a probable scenario when the mood of the Euro-zone members gets ´subzero´ and people want retaliation for the money lost on Greece. This is the populist approach, as advocated by the True Finns from Finland and the PVV (Party for ‘Freedom’ in The Netherlands). A mentally sane Europe will never choose for this option.

·        The problem is solved, as the Greeks will never bother the other Euro-zone countries anymore.
·        This solution satisfies – in a populist way – the public anger in countries like Germany, The Netherlands and Finland on ‘those stupid, corrupted and lazy Greeks’.
·        Greek personnel and products will be very cheap, when priced in Drachmes, as this currency will soon not be worth the paper it is printed on. This might improve the export of goods and products.

·        Greece needs to go again through the introduction process of a new currency. This will cost 2-4 years and billions of Euro’s.
·        Middle-class and lower class people in Greece might suffer from poverty, as all foreign products will be extremely expensive after leaving the Euro.
·        The Greek economy will return ‘to the stone-age’ (i.e. the pre-Euro times) and the country will lose track to the development of the rest of Western Europe.
·        The aforementioned French and German banks will suffer enormous losses: either their debt is quoted in Drachmes which will cost those banks money, or Greece will default which will cost them money. It is a lose-lose situation.

Final outcome
The Greek will readopt the Drachme, try to get their debt quoted in Drachmes and devaluate this into oblivion. If Greece can’t get its debt quoted in Drachmes, the country will default after all. This will be a serious blow for the large European banks with substantial exposure to Greece. The populist parties will celebrate this as an enormous victory, but actually it will be a great loss for Europe.

Scenario 4: The Euro is split up in two or three baby-euro’s: Northern Euro, Central Euro and Southern Euro

Probability: This is really a ridiculous idea and I only discuss it for the sake of being complete. Instead of heaving one currency with its disadvantages, but with the power of a well-respected, united currency, two or three smaller fiat currencies evolve without any track record. Can you imagine that? I can’t.

It is not a probable outcome that the Southern-Euro all say: ‘please Northern-Europe, take the current Euro. We will invent a new currency and design new paper and coins. On top of that we will pay all the costs, because we’ll have plenty of money’. So both groups will have to reinvent a currency and decide the exchange rates of their own fictive currencies in the N-Euro (Northern) and S-Euro 1.1.

·        The strong countries would theoretically have a strong and trusted currency.
·        The PIIGS would have a chance to devaluate their S-Euro and thus make their labor and products cheaper. This would reinforce their competitive power.

·        All Euro-countries would have to go once again through a extremely costly introduction of a new currency and many battles will be fought over the relative value of the countries’ economies to set the exchange rates.
·        This process will take 2 to 4 years; just like the Euro introduction and in the meantime, the jeering from the US, China and Japan will sound over the oceans.

Final outcome 
This solution doesn’t solve anything. The problems in the PIIGS will remain the same and their debt will eventually get a haircut: either by devaluating the S-Euro or by a straightaway default of one or more of the countries. Also the N-Euro will not be as strong as the original Euro. The process will cost billions of Euro’s and it will cost years to regain the trust of the financial markets.

Scenario 5: The Euro will implode and all members will return to their old currency’s.

Probability: When I said that scenario 4 is a bad and improbable scenario, this is even more true for scenario 5. This seems like a good dream for all populist parties, but it will create financial chaos in all countries. The whole of Europe will again be ‘lost in translation’  and all countries will have to spend billions of Euro’s and 2-4 years to reinvent their old currencies again.

·        Poor countries will devaluate their currencies into oblivion, in order to create better export markets.
·        Rich countries will have again a sole responsibility for their own currency and The Netherlands with its Dutch guilder will follow the D-Mark 1.1 again very closely.
·        After ten years of confusion, the D-Mark and Guilder will be rockhard again.

·        The whole economic development of the Euro-zone will be thrown back for at least ten years.
·        The export will implode to levels of 15 years back.
·        On a trip from The Netherlands to Portugal, you will need 5 currencies again: Escudo, Peseta, French Frank, Belgian Frank and Guilder.
·        The jeering from the US, China and Japan will be even louder than with scenario 4.

Final outcome 
Although I’m a natural optimist, I am certain that the populist voice in Europe will gain momentum when this option is chosen. This could lead to acrimony within the EU and eventually to the dismantling of the EU. Option of last resort might even be war, when tensions soar beyond the dismantlement of the EU..

The other powerful countries in the world will prosper from this new dividedness within Europe; especially China will do everything to gain influence, by financial enslavement of countries.


In my opinion, there is only one sustainable solution: allow the Greeks their financial haircut, but execute this plan as mentioned by Kees de Kort: Only allow a haircut when a total restructuring of the Greek economy takes place with the help of the other (and stronger) European countries. The same recipe should be used when other Euro-countries are in distress. Don´t try to kick the can, but solve the problem by allowing a haircut and helping the countries to restructure their credit and economy. Then the Euro will have a good chance of surviving.

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