Could Germany just leave the euro zone? Not easily.
The warnings on Europe sound extra-apocalyptic this week. “The eurozone really only has days to avoid collapse,” blares the headline on Wolfgang Münchau’s column. And, while European leaders are frantically thrashing out plans for further fiscal union to save the euro, German Chancellor Angela Merkel is still resisting sweeping reform measures. As my colleagues Michael Birnbaum and Anthony Faiola report, “investors and world leaders alike hang on Merkel’s every word, searching for a hint that her resistance is simply a bluff to scare countries into behaving more like hers.”
And maybe Merkel is just bluffing. But plenty of observers seem freaked out enough to start asking the question no one wants to ask: What would a breakup of the euro zone actually look like? The FT’s Gavyn Davies runs through some likely scenarios. Maybe a few periphery countries like Greece and Ireland decide to exit the euro zone, default on their debts, and revert back to their old, devalued currencies in order to start afresh. Or, alternatively, maybe financially stable countries like Germany and the Netherlands decide to leave the euro, bid their troubled neighbors adieu, and form their own, smaller currency zone.
These sorts of scenarios are no longer unthinkable. But a recent report suggests that either move would be far more painful than most people seem to realize. Indeed, a crack-up could prove far more costly to Germany than a bailout of its neighbors.
In September, economists at UBS Investment Research tried to tally up the costs of seceding from the euro. If a “weak” country like Greece tried to leave the euro, it would almost certainly have to default on its national debt, watch its domestic banking system collapse — every halfway-sentient depositor would rush to withdraw euros before they got converted to new, less-valuable drachmas — and the country would get rocked by big trade disruptions and unrest. UBS estimates that a “weak” country like Greece or Ireland leaving the euro would take a hit of up to 50 percent of its GDP in the first year alone, and then a 15 percent hit per year for the next few years. That’s a crushing blow.
Now, what would happen if a financially sound country like Germany decided to leave the euro, in order to maintain its own currency? Even that would hurt. A lot. Germany wouldn’t default on its national debt — in fact, its new currency would likely be worth more than the old euro — but its banks would suddenly have assets in the old, devalued currency. Balance sheets would be thrown out of whack, and Germany would have to pour an enormous amount of money into bailing out its banks. What’s more, the country’s exports would likely collapse. All told, UBS estimates, the cost of secession to a country like Germany would likely reach 20 percent to 25 percent of GDP, and remain at about half that for a few years thereafter.
One thing UBS notes is that it would be much, much cheaper for Germany to simply bail out Greece, Ireland, and Portugal outright (that would cost about 1,000 euros for every German man, woman and child in one swoop) than it would be for Germany to exit the euro zone (which would cost the average German 8,000 euros the first year and 4,500 euros thereafter). Bailouts are deeply unpopular in Germany, and for good reason, but they look like the cheaper path. Even Bernard Connolly’s estimate that it would cost Germany 7 percent of its GDP for several years to bail out all troubled euro zone countries, up to and including France, looks like a less-painful option at this point.
Indeed, that’s why the UBS report suggests that it would be insane for Germany to let the euro fracture, and argues that there’s “an overwhelming probability” that the euro zone moves toward some sort of fiscal integration — which partly means German taxpayers bailing out the Mediterranean neighbors it deems irresponsible. Of course, even if that’s the more rational approach, that doesn’t mean that will be the end result.