Pricing the German costs of a euro break-up | FT Alphaville

Pricing the German costs of a euro break-up

Calculating the benefit to Germany from eurozone membership has been attempted numerous times, and proven rather hard to pin down. But what about the opposite? The costs to the country of a euro break-up? Given the importance of Germany’s support to the survival of the euro project, this is a big question, with a tonne of political baggage attached.

The German ministry of finance has done just such an analysis, according to Der Spiegel, and found that the costs of such a break-up and the re-introduction of the D-Mark would lead to an up to 10 per cent fall in GDP in the first year. Unemployment would surge to its record high of over 5m.

Interestingly, the ministry spokeswoman claims she’s unaware of such a study, but we find it difficult to believe a serious publication such as Der Spiegel would have run such a story, on its front cover, if the report was just a figment of someone’s imagination. But because of the ministry’s denial, we don’t have the report or know how these figures were estimated.

To put them in context, however, Germany had 2.87m unemployed last month according to the Federal Labour Agency, so the prediction is for a near-doubling of unemployment in case of a break-up. And 10 per cent of its economy is around €257bn (based on 2011) figures. But that’s just the first year’s estimated drop in GDP, presumably the impact would last several years so the total costs would be higher.

With the subheading “Treasury anticipates catastrophic consequences for the German economy after the possible collapse of the euro”, Der Spiegel evidently expects the German reader to balk at the 10 per cent figure, as does the finance ministry, hence the presumed burial of the report. From Der Spiegel:

According to their [the German Finance Ministry's] scenarios, in the first year following a euro collapse, the German economy would shrink by up to 10 percent and the ranks of the unemployed would swell to more than 5 million people. The officials were so horrified by their conclusions that they kept all of their analyses confidential, for fear that the costs of rescuing the euro could spin out of control. “Compared to such scenarios, a rescue, no matter how expensive it is, seems to be the lesser evil,” says one Finance Ministry official.

Keeping the euro going is the smaller or, rather, cheaper evil for Germany? Maybe it is, maybe it’s not. But what’s in fact overall cheaper/better for Germany is secondary to what’s politically feasible right right now. Public opinion in Germany for the euro is dropping fast. From Bloomberg on June 24:

Germans showed the lowest support for the euro among the four largest nations using the currency, according to a poll published in four European newspapers today.

The poll shows 39 percent of Germans favor leaving the euro, versus 28 percent of Italians, 26 percent of French and 24 percent of Spaniards, according to the survey, conducted by Ifop-Fiducial and published in Madrid-based ABC, Germany’s Bild, Italy’s Corriere della Sera and Le Journal du Dimanche.

In all four countries, majorities said that loans to Greece will never be paid back, even as most said that not saving Greece would increase the euro region’s difficulties “dangerously,” ABC said. In France and Germany, most of those polled said Greece should leave the euro if it can’t pay back its loans, while in Italy and Spain about half shared that view.

And that’s something to be worried about because, as much as we worry about a Grexit, it is “strong, rather than weak, countries end monetary unions”, according to Thomas Costerg and team at Standard Chartered. They have looked at past cases of currency breakups, namely the Soviet Union, Czechoslovakia and Argentina:

In our three examples from history, it was the stronger countries or partners that brought unions to an end. The departure of the Baltics, and then Russia’s actions, ended the RUB bloc; in Czechoslovakia, mounting imbalances made the Czechs (the stronger partner) keen to accelerate a breakup; in the case of Argentina there wasn’t another country directly involved, but when the IMF (backed by the US) gave up, the game was over.

Closer political union would help save the euro, but:

In our view, political strains among the euro-area members pose the greatest threat to the survival of the euro (EUR). The current crisis has demonstrated ongoing shortcomings in leadership, governance and coordination. At the same time, grassroots support for the EUR is fading in some countries … anti-EUR political parties are gaining strength (though still firmly in a minority), and in the periphery there is growing resistance to the implementation of policies aimed at shoring up the single currency.

The drop in euro support in Germany is particularly problematic. It’s hard to imagine how the currency could keep going without Berlin’s support:

German public opinion is lukewarm at best, while policy-maker nervousness over Germany’s increasing exposure through Target2 and potentially, the bailout mechanisms, is growing. Some commentators believe that a German exit and revaluation would ultimately benefit the (rump) EMU, but without the financial backing of Germany, and the credibility of a German-backed ECB, it is difficult to see the euro area surviving such a move.

This is why it’s as important to understand what the German public is thinking and reading, as it is to dissect Angela Merkel’s and Wolfgang Schäuble’s every uttering and panic about Target2 imbalances. Merkel has elections to fight in 15 months time, and in the coming months she is going to have to dance more and more to the tune her voters set.

Related links:
History lesson: the break-up of monetary unions -Also Sprach Analyst
‘We Certainly Don’t Want to Divide Europe’ – Der Spiegel