What Would Be The Worst Case Scenario For The Euro

I know there have been a few threads about the Euro and I will also admit, understanding the finance is not my strong point.

But I was reading how if Italy has any more problems it will be fatal to the Euro and cause a big economic mess. I guess Italy unlike the others is too big to bail out so they’ll just have to fail, which will lead to chaos.

But in theory what would be some worst case scenarios for the Euro? I guess the absolute worst would be that the nations of the EU go back to their own currency.

OK would this possibly happen? If so how would that effect other non-EU nations.

Would the end of the Euro destroy the EU or just set it back?

I must admit, I am not sure of even how to ask this question properly. It’s just I read the news and it seems every day people are predicting dire things for the Euro, if it collapses. But they don’t say what a collapse is or how bad it could be or what “worse case” would happen.

This may be more of an IMHO than GQ so feel free to move it where it best fits

I also realize, what you answer can never be a definite answer but a simple logic flow might help me get it.

Like, Italy fails, this causes “A” which is liable to lead to “B” which lead to this it may cause “C” which leads this way…

And so forth…Thank you

Well, as I see it, the Euro is under pressure because of the high debt level of nations like Italy, Greece, Spain, Portugal, Ireland (and now, Belgium). This is reflected in the high interest rates demanded by bond purchasers.
Germany and France (the largest EU economies) have hndreds of billions of euros exposed (loans to the weak nations), so they have had to borrow more-adding more pressure on the ero.
Eventually, nations like Greece will be unable to roll over its debt-in which case it wil default. This will trigger a run on the euro-in effect everyone will be selling, no one will be buying. This will cause the currency to collapse. Could this happen?
If the Chinese central bank refuses to buy european bonds, this could happen.

Great Depression 2.0 is the worst case scenario.

Yes, it could happen.

The effect on the rest of the world is likely to be depression.

The eurozone and the EU are not identical. The end of the euro doesn’t change the EU.

Step by step here.

People don’t think Italy will be able to pay its debts.

Italian banks own a lot of this Italian government debt. If Italy can’t pay its debt, then Italian banks lose their money. They can’t pay back deposits on demand.

Italian banks fail. Not one of them. Not some of them. All of them are attacked at once. It’s a country-wide bank run, as people try to get their money safe out of the banks.

Italy is forced to shut down its entire banking system. They can’t allow the whole money system to collapse, so they institute strict “capital controls” – rules that restrict the flow of funds out of banks. Euros can no longer be transferred freely from Italian bank ledgers to other eurozone bank ledgers. Italian bank money is effectively no longer the euro, since it can no longer be exchanged freely. The euro has already lost its first member, and the breakdown of the machine is only just beginning.

(Note: this is all electronic money, which is the majority of money. The actual paper banknotes are another story. They might all be stamped with a big red “NOT A EURO ANYMORE” stamp, at least the ones that aren’t smuggled out. That’s a huge bloody mess in itself.)

The bank panic extends to other periphery countries. The PIGS are hit for sure. They suffer the same bank run Italy has. This is the biggest bank run in history. They’re also forced to stop operations while their respective governments institute capital controls. The euro loses even more members.

German and French banks, the core of the eurozone, aren’t immune. They’re next on the block. At this point, if they haven’t done so already, the Germans will finally relent and allow what’s left of the ECB to save what’s left of the eurozone financial system. After failing to save Italy, they will decide to save their own countries’ banks. (This is worst case scenario talk here. It’s possible they’ll move before this.)

Money is the lifeblood of the economy. The circulation of this money in Europe has stopped. Trillions of dollars are locked up, unavailable, effectively disappeared for the present. With the euro financial system suffering cardiac arrest, the circulation of money worldwide suffers.

Exposed banks fail in London, New York, Tokyo, and everywhere else. The world economy tanks. Depression ensues.

That is what could happen.

This is what road they’re currently on. It not only could happen like this, it will happen like this unless the European Central Bank steps up to stop it. Which they’ve declared, over and over, that they’re not going to do. More money is needed, and they’re the only ones who can provide it. The only thing that’s really stopping the first domino falling is the odd chance that the ECB is lying about its intentions. The ECB is essentially telling the world that they’re going to fiddle while Rome (and the rest of Italy) burns, and the world is thinking that they can’t fucking be serious about that. Eventually, if the world decides that the ECB is honestly committed to its stated policy of negligence, then the disaster will be free to commence. The run will begin.

Is this likely to happen? Well… I don’t got a crystal ball. What the ECB is trying to avoid is awarding bad behavior. They don’t want to bail out countries that will then abuse that bailout by being irresponsible in the future, and thus in need of yet more bailouts. This is called “moral hazard”. It’s a legitimate fear.

The problem is that there will be a massive cry across Europe to stop the financial crisis when they’re on the verge of the mother of all bank runs. If the ECB waits until the last possible second, until the bank run is already commencing, to backstop the system, then they will have zero time to make good choices about who to save and who not to save. If they decide to step in, they’ll be forced to save everybody, without any limits at all, because they won’t have time to distinguish good from bad. If they wait until the last second, then the moral hazard they’re so damn concerned about will be an even bigger concern than it would be if they helped right now.

Right now, it’s different. If they committed themselves to a more expansionary policy – say, committed to returning to the previous trend line in nominal spending – then they’d relieve the stress on the system a bit. It could, maybe, give them enough time to make better choices to reduce moral hazard. But in that case, the Germans would be forced to admit that they have to eat higher inflation. And the Germans hate inflation. In fact, controlling inflation is the ECB’s only real stated job. Now, Germany will have to eat this inflation anyway, one way or another. Once the dominoes start to fall, their resistance to backstop the system will vanish immediately. They’d be happy to backstop the system if their own banks are on the line. And their own banks will be on the line. They’re going to eat that inflation, one way or another. They just haven’t admitted that to themselves yet.

If you want a good historical overview of dominoes falling, you can look at the gold standard during the Great Depression. Once countries started devaluing their currencies (dropping their gold pegs), then other countries had to follow suit. It will be a similar deal this time, with promises to tolerate inflation in order to save the system. Either they backstop the whole system before countries break off from the euro, or they backstop their own system after countries have already broken off.

Before would be much better than after, but they seem committed to see that first domino fall. They’re going to get their wish before too terribly long.

Very complete answer, Helestal. Are you sure you’re not Paul Krugman? It is what he has been saying for months.

Hellestal, you’re scaring the shit out of me! :eek: :eek:
When, do you think, all this will start? Should I put my money in gold?

It’s even worse than that. Italy will be the 2nd to fail after Greece. The currently proposed “voluntary” restructuring / haircut will not be enough to solve their problem. But it will be enough to destabilize the rest of the system up to, and perhaps over, the tipping point.

Gold is waay overpriced now. That would be a bad thing to buy. Besides, you can’t eat it when teh chips are *really *down.

LSLGuy:

Says who?

So, the euro collapses…what next?
Is Germany better off now?
I imagine a euro collapse would provoke a worldwide depression.
Would the German Central Bank then consider an inflationary policy? Or are the memories of the 1920’s too strong?

There is really only two choices.

Default or print Euros.

Allowing countries to default is much too much “out in the open”. The people could clearly see that the governments did nothing and allowed it to happen. This will cause anger toward the politicians. This cannot be allowed.

Inflating the currency will be the choice by printing billions of Euros. Through history governments have cleverly hidden the fact that they and their currency printing presses are the reason for inflation. The authorities will inflate the currency “behind closed doors”. And when inflation and later hyper inflation hits, these authorities will claim no knowledge as to why this has happened. They will blame the greedy merchants for raising prices, and the banks for closing their doors.

Great post Hellestal.

…and once a country depreciated, recovery typically followed.

Six percent inflation (say) would make inflation-adjusted interest rates very low, spurring recovery. Nominal GDP targeting could keep worries about inflation in the teens at bay.

So is Great Depression 2.0 possible under such circumstances? Sure. The collapse of the financial infrastructure occurred during Great Depression. And without credit, it’s hard to run a small or large business. So when/if a country leaves the Euro, keep a careful eye on its banks: if the oligarchs are bailed out, that will be a promising sign. There’s nothing in Hellestal’s catastrophic scenario that makes a 2nd Great Depression a necessity, but the challenge may surpass what TPTB are willing or able to deliver. In nations such as the US where the opposition retains considerable stopping power, some will have incentive to permit economic calamity up to a point.

One difference is that Krugman seems to think that long run concerns about moral hazard and the like are severely misplaced when the house is already on fire. And thinking that late 1980s levels of inflation would be horrible is silly, according to this view.

We won’t be looking at 25% unemployment. It could be bad, but it won’t be 1930s bad.

And I’m not an investment person. I can give if-then scenarios, but I can’t put any realistic weights on whether the if’s will come to pass.

Not typically. Always.

The problem is acting now instead of later. Breaking off from the euro will be massively more painful than refusing to redeem paper for gold. It would require rebuilding the banking system on the fly, instead of just telling banks that they should not longer hand out precious coins on demand.

Exactly.

No guarantees, but it’s the best plan available. (They show no interest in pursuing any plan whatever right now.)

I actually think the concern is ridiculous, too. My point was just that it’s not a phantom fear. Moral hazard is real.

But like the gold complainers of the 30s, it’s a misplaced concern, “crying fire, fire, in Noah’s flood”. Fire is legitimately dangerous, it’s just a silly thing to focus on at the moment.

If we’re talking “worst case scenario” here, then we are indeed talking Great-Depression-bad, 25% unemployment and all, in both Europe and the US. Spain and Greece are already approaching 25% unemployment. I think policymakers will see some measure of sense before that but they haven’t exactly been covering themselves in glory for the last two years so who knows what could happen.

Trillions. It would be trillions of euros.

Please. The US has expanded its monetary base by about two trillion so far, and US core inflation is around 2%. Headline inflation is obviously higher, but there’s nothing we can do about supply disruptions from a series of revolutions in oil-rich countries. There would also be no blaming of “greedy merchants”. Everyone knows where new monetary base comes from.

We’re not talking about hyperinflation if the ECB steps in. It wouldn’t even have to reach 1970s inflation levels, if they concentrated on stabilizing NGDP in the eurozone.

Sorry, I was being ethnocentric there. You’re right about Europe.

No way the US sees 25% unemployment, though. We’re not chained to gold like Spain is chained to the euro.

Spain is already nearing 25% unemployment; in a worst case scenario they’re looking at an apocalyptic level. The US is currently just below 10% unemployment, with interest rates already chained to zero and the combination of the federal deficit and the political climate already making fiscal stimulus measures difficult. Combine that situation with the fact that the Eurozone is the US’s largest trading partner, accounting for nearly a fifth of its trade, and that the US and European financial systems are tightly interconnected, and I think 25% unemployment in the US is imaginable in the worst-case scenario (ie. something approaching a collapse of the European financial system).

Spain is chained to the euro. The US isn’t. That’s all there is to it.

Interest rates are just about meaningless in this context. They’re not chaining anything. There is nothing stopping the further easing of money at zero, it just has to be done in unconventional ways.

This could only happen if the US decided to mimic Europe by being so afraid of inflation that it would allow its own system to buckle in the same way. That’s not credible with Bernanke as chair.

Look at the Depression. Recovery could proceed as soon as countries dropped their gold pegs. A massive easing of money from the Fed in the wake of eurozone collapse would be similar to abandoning gold. I’m not saying it would be pleasant. We’d shoot above 10% easy. But there’s no way they’re going to sit with their thumbs in their asses if the eurozone buckles. It would be extremely bad for the US, but not Great Depression bad.

Do you have anything backing any of this up? The idea that you can confidently predict exactly what the upper limit on US unemployment would be in a scenario where the European financial system has collapsed and US inflation has (somehow) shot above 10% is fanciful. The US and European financial systems are vastly interconnected; if one of their financial systems literally collapses, in a worst case scenario, the other country is going to see historic suffering, and I don’t see why that couldn’t conceivably include 25+% unemployment.

I like how you prefer to talk about the “core” inflation rate as if food and energy some how shouldn’t count. The government says these two areas are too “volatile”. They are not volatile, they go up up up and the government doesn’t want the public to know the real inflation rate. When I open my wallet at the supermarket or the gas station, I can tell you prices have gone up more than 2%.

Its like when Washington says the unemployment rate is 9% and doesn’t consider a person officially unemployed because they have supposedly stopped looking for work. That person would take a job in a minute if they could find one.

And everyone does NOT know what causes inflation. You’ll never hear any one in government admit to inflating the currency. And the average person on the street has no idea its the government printing presses that is the cause of inflation. They have been told that its the businesses that are unjustly raising their prices and if they don’t stop it the government will impose price controls.

If Deutche Bank Germany collapses, the Fed can open its credit line to Deutsche Bank USA. Moreover, if money market funds find that their investments in Euro bonds go south, the Fed can still do extraordinary things in extraordinary circumstances. I think. The shadow banking system (which includes money market funds) is probably the vector of vulnerability.

No. You misunderstand. If you are deciding how to compensate people for inflation when cutting social security checks, you use headline CPI. When you are working out long and medium run inflationary pressures, you can ignore the subset of prices that fluctuates a lot. These are separate problems, so it makes sense to use separate measures. You don’t use the Kelvin scale when commenting about the weather, and you don’t use Fahrenheit when discussing superconductors.

Oh. Really : http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=GASREGW&s[1][range]=1yr] (The link contains brackets which don’t render: sorry)

MIT’s series is consistent with the BLS’s, so the conspiracy is pretty broad.

The BLS puts out series that include discouraged workers. They have a dozen or so measures for unemployment. The TV news typically reports one. The New York Times’ business pages will report a few.

I know very little about auto mechanics. You don’t learn about economics in the cradle: it requires study. And the idea that printing presses cause inflation is a simplification.

Take a look at what has happened to the monetary base. http://research.stlouisfed.org/fred2/series/BASE
If prices went up lockstep with Fed open market operations, they would have gone up threefold by now. Instead, we’ve had headline inflation of 3.5% for the past year, and 1.1% a year ago.

The answer is… unknown.

Current financial systems in developed countries in the past 50 years or so are heavily dependent on speculation and straight out gambling.

That’s what the EU monetary system shifted its focus on in the past 30 years… speculation and gambling.

Germany can withstand any potential crisis because their economy is still self sustainable. But there aren’t any more countries that can do the same thing … maybe one more or two at the most.

The collapse of the Euro will be a clear indicator of the un-sustainability of global financial speculation. No one knows what will happen next.

Maybe someone will invent the next level of economic interaction between countries that does not depend on gambling.

Cite?

Cite? Note that I’m not saying that speculation and gambling haven’t taken place, but are they the focus of the EU monetary system?