Eurozone shakeout ‘highly probable’

19th November 2010

Speaking at a conference in London yesterday, Alan Brown, chief investment officer at Schroders, said that while all the signs are that there could well be an eventual shakeout of the eurozone, it was uncertain whether this would be achieved by large trade surplus members like Germany exiting or through the troubled ‘peripheral' countries like Portugal, Spain and Ireland leaving.

Brown, addressing attendants to Schroders International Media Conference 2010, stressed that at the moment it is not inevitable such a breakup will occur, merely that that the probability is ‘high'.

Catalyst for fiscal union

He noted, interestingly, that another potential result from the sovereign debt saga failing to be resolved is that the eurocrisis serves as a catalyst for fiscal union, something that was left out of the equation when the euro was created.

However, in the current climate, with such enormous disparities between members' finances, fiscal union would be extremely difficult to achieve.

The travails of the eurozone seem extraordinary but Brown, a keen historian of currency unions, points out that the failure of such unions in the past has been much more common than one might think.  

After ignoring currency breakups related to political dissolutions – for instance, Yugoslavia; currency boards, a monetary authority which is required to maintain a fixed exchange rate with a foreign currency; and unions where the exchange rate is not 1:1, Brown has found that an astonishing 69 currency unions have dissolved since World War II.

Political project

The euro above all has been a political project – its founders made little show of pretending otherwise, much to the consternation of many economists at the time of its launch who feared precisely the kind of dislocations taking place now. Moreover, the euro is a multi-national union but with one currency and one central bank.  

A little late in the day, euroland is finding out that economic realities really do matter. Brown points out, for instance, that relative to Germany, the troubled peripherals, Greece, Ireland, Portugal and Spain, have lost between 18% and 33% of their competitiveness. 

With no fiscal discipline having been integrated into the system, these relative strengths have led to massive problems in relative performance and financial management of economies. In the first decade of the euro project, for instance, demand in Greece soared by 37% while in Germany it only increased 3%.

It certainly looks like Ireland will agree to an international bailout. Earlier today AFP reported that International financial experts from the European Union and IMF and Irish officials have begun tough negotiations on a possible bailout for the debt-ridden economy.

Focus on Greece

Ireland's woes though have again forced the market to focus heavily on the peripherals, especially Greece. The IMF itself estimates that even if it manages to follow through with the all the austerity measures being imposed – a very big ask in itself –  the country's debt-to-GDP ratio will register close to an eyewatering 150% by 2012.

It is worth noting that since the modern Greek state was founded in 1830, the country has, on average, been in sovereign default every other year. It has been through five big defaults in less than 200 years.

Summing up his view on the euro, Brown urges investors to firstly recognise that volatility is not the only risk in relation to the union.  

"If one of more members of the euro exit, conventional wisdom says that the European economies and markets will be in disarray. But history, as we have seen, suggests breaking up is not so hard. It can be quite liberating to be released from the straitjacket!"

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