Click Nomura chart to enlarge:
Along with “redenomination risk” for eurozone financial assets, this is another of those pieces of bank research that’s as interesting for being considered necessary to be written in the first place, as much as for its conclusion.
(Yes, we know it’s a dampener to talk about a euro break-up when the German and French governments are promising European unification, sweetness and light on a scale not seen since Charlemagne. But since it really is about either complete fiscal union, or this — it’s worth noting.)
Once again it’s Nomura taking the plunge on covering the break-up issue. In his December 4 note, the bank’s FX analyst Jens Nordvig warned that conclusions about the value of a post-euro currencies would have to be extremely provisional:
…we want to stress up-front that these estimates are unlikely to be particularly precise. They are intended to give a sense of potential magnitudes involved over a 5-year forward time frame, after which we believe temporary transition effects should be smaller.
A eurozone break-up will create additional short-term risks and require new risk premia for investors. These extraordinary risk premia will vary by country depending on factors such as market volatility, liquidity conditions, as well as issues relating to capital controls, including possible taxes on capital flows. Since our analysis is focussed on equilibrium considerations over a 5-year period, we will not focus directly on these more temporary effects, although we recognize that they could be crucial in the short-term.
To be sure, those effects could be huge. If you consider Germany as an example, there might be a massive capital preservation premium in buying Deutschmarks on a euro break-up, beyond its ‘natural’ currency strength. At the same time, who knows what would be the impact on the currency if German banks were blown up by a euro exit.
As a general point, it’s not clear whether you could even trade in national currencies breaking away from the euro, if capital controls were used – making spot FX transactions and so on extremely difficult. Furthering the point, the actual national laws removing the euro as a country’s lawful currency could use a “statutory” conversion rate that would be very different to the exchange rates that markets would like.
See what we mean? Tricky.
So what is Nomura looking at, to get the numbers above? It’s a combination of countries’ real effective exchange rates (so things like structural deficits and competitiveness that have been ‘masked’ by the euro) and risks from inflation in each country. The latter’s interesting because you’d have to think in detail about how national economies would operate beyond the euro, on everything from liquidity support for banks to how much price increases would pass through to wages. It’s interesting too because…
…Plenty of emerging-market sovereigns have been here before. Ultimately this would be about devolving from a debt crisis to several currency crises all going on at once. Bit of a paradigm shift — if it does happen.