UBS doubts your eurozone contingency plan is good enough

The latest eurozone missive from UBS’ global economics team is out, and they sound worried that their earlier reports were not adequately scary taken seriously enough.

Yes, the euro is deeply flawed, say Paul Donovan, Stephane Deo and Larry Hatheway. They were were pointing this out before it was cool.

But no, breaking it up is not the solution, mostly for the reasons they’ve previously outlined. In short: it would be expensive, messy, painful, and possibly even dangerous (not just in the financial sense). Even a ‘secession’ of one country could very well lead to all kinds of chaos, for strong countries and weak. And a euro break-up — labelled ‘collapse’, here — is worse:

UBS - euro collapse and euro secession scenarios

So, in a separate note, Hatheway scoffs at your scrappy “planning” for a break-up scenario:

Talk about fantasy. That’s like asking Wellington to stress test his army against a scenario where Napoleon has a B-52 at Waterloo. You don’t re-position the troops—you retreat as quickly as possible across the channel, if not across the Atlantic.

Of course, we get it, contingency planning is prudent. But just what contingency are we planning for? In break-up new currencies will be introduced. But will they trade freely? Probably not. As we noted in our original piece on the costs of break-up, it is highly probable that capital controls would accompany exit. Spot, forward, futures, swaps, options and other currency derivative contracts might not even materialize, or perhaps only for limited current account transactions. Companies preparing plans on how they might manage multi-currency cash flows in a post-Eurozone world might be advised instead to pay attention to the risk of not getting paid at all, never mind in which currency. Counterparty risk—bank-to-bank and company-to-company—would soar as defaults mount.

So, what should you do? Apart from hoping like hell that the relevant eurozone leaders do the right thing? Here is Hatheway again. Emphasis ours…

Simply put, linear thinking doesn’t work in a non-linear world. And break-up is likely to produce a very non-linear set of outcomes.

Which brings me, lastly, to the question I sometimes get about what is the ‘right’ asset allocation in the event of break-up.

I suppose there might be some assets worthy of consideration—precious metals, for example. But other metals would make wise investments, too. Among them tinned goods and small calibre weapons.

Break-up runs the risk of becoming one wretched scenario. Sadly, however, it can’t be ruled out, just as it would have been improper to rule out the horrors of the first half of the 20th century before they happened.

But it is very hard to see break-up as a solution. Let’s hope Europe’s politicians and policymakers agree and take action this week to fix what is broken before it all really breaks up.

Yep. Let’s do that.

Related links:
The catastrophe of failure does not ensure success – FT Alphaville
Disorderly default, almost as bad as civil war - FT Alphaville
Lawyers plan for possible eurozone break-up – FT
Thinking the unfolding: the break-up of monetary union – FT Alphaville

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