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The consequences of a euro zone breakup

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We keeping hearing that a breakup of the euro zone is “unthinkable.” But a number of analysts have decided the situation in Europe looks scary enough that they should at least start pondering it. Already we’ve seen UBS Investment Research depict a doomsday scenario for a euro crack-up. And now the financial analysts at ING have written their own assessment (PDF) offering up all sorts of graphs on how a Greece exit or a total euro breakup would hurt different countries in Europe:

The ING analysis is considerably less dire than the UBS report — the latter predicted that Greece could lose half its output in the first year alone. But even this analysis is pretty bleak. ING predicts that a total fracture would cause the euro zone’s output to drop 12 percent in the first two years alone — worse than what happened after the collapse of Lehman Brothers in September 2008. The resulting chaos would also send the United States into “at least a mild recession” in early 2012. Granted, these aren’t the only two options — there are intermediate break-up scenarios where Germany and a few other strong euro members keep a common currency — but this graph offers a worst-case look.

Because the fallout would be so grim, ING still believes that countries like Germany and France will eventually decide to grit their teeth and salvage the euro rather than let the currency union fall apart. “Our base case,” the report notes, “remains that [the euro] will survive, courtesy of a ‘Grand Bargain’ that exchanges tighter fiscal discipline and economic reform for German support for ECB action to aid the funding of peripheral governments and banks and a commitment to launch a common Eurozone government bond.” On the other hand, European Central Bank president Mario Draghi seemed to rule out direct aid from the ECB today, so that could complicate matter somewhat.

What’s more, while ING estimates that a successful “grand bargain” of the sort that’s being complicated would be cheaper than a breakup, there’s always the possibility that even a grand bargain would fail. Tyler Cowen broached this topic awhile ago: “Do not think that Germany has merely to wave a magic wand, or incur a one-time cost, to set things right in the eurozone. Any ‘set things right’ action on Germany’s part is, one way or another, a form of doubling down. If it fails it means a bigger eurozone implosion in the future than would happen now, including much higher costs for Germany.” It’s not hard to conjure up dire scenarios in which a breakup of the euro, however painful, could be the cheaper option.

Interestingly, László Andor, the EU Commissioner for Employment, Social Affairs, and Inclusion tweeted the ING analysis earlier Thursday, although he seemed to be more focused on the report’s implicit criticisms of German Chancellor Angela Merkel’s go-slow approach to resolving the crisis than on its doomsday euro implosion scenario.

(Links via FT’s Alphaville.)

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