Leaving the Euro: What Would It Cost?

The euro zone was created with easy entry and virtually no exit. It was designed to go forward only and have no reverse gear. A German court ruling Wednesday, which confirmed that the government has the authority to continue using taxpayer funds to bail out Greece and other economic weaklings, makes that clear.

So does a new study by UBS on the consequences of a country leaving the euro, or the currency bloc falling apart altogether. There is no mechanism for kicking anyone out, it notes. As much as citizens of countries that have lived within their means, mainly in northern mainland Europe, might like to kick their more profligate brethren in places like Portugal, Italy, Ireland and Greece out of the euro zone, the various treaties governing the European Union and the currency forbid that, the study points out.

That's just as well, it concludes, because as expensive as the continuing bailouts and belt tightenings may be, the cost of dropping the euro for weak countries would be higher. The same is true, it says, for any stronger euro zone member that got fed up and decided to leave.

As a practical matter, the study's authors contend, it's about as impossible for a country to drop out as to be forced out. There would be costs of various sorts, and they would be prohibitive.

The currency would be worth 60 percent less against the euro than when the country entered into monetary union and adopted the euro, the UBS analysis estimates. There would be a mitigating benefit from a reduction in export prices that the devaluation would bring, but only a slight one, they reckon. The bottom line:

"We estimate that a weak euro country leaving the euro would incur a cost of around 9,500 to 11,500 euros per person in the exiting country during the first year. That cost would then probably amount to 3,000 to 4,000 euros per person per year over subsequent years. That equates to a range of 40 percent to 50 percent of [economic output] in the first year.
". . . If Germany were to leave, we believe the cost to be around 6,000 to 8,000 euros for every German adult and child in the first year and a range of 3,500 to 4,500 euros per person per year thereafter. That is the equivalent of 20 percent to 25 percent of [economic output] in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over 1,000 euros per person, in a single hit."
On the next page: The costs aren't just in euros and cents. There are some intangibles in the potential itemized bill that UBS has devised. The analysis argues that any country leaving the euro would be in violation of various treaties and might therefore have to leave the European Union too. That's not all:

"The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the euro would incur political costs. Europe's 'soft power' influence internationally would cease (as the concept of 'Europe' as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war."
The impact on financial markets was not dealt with at length in the study, but it did suggest that an exit from the euro most likely would provide a sharp downward jolt to stock and bond markets in the affected country. The study did not go this far, but a defection from the euro probably would hit markets in other euro zone countries and around the world too.

After the dust settles, though, there could be bargains galore. Stocks of exporters in weak countries that leave the euro would be expected to benefit from pricing goods in a drastically devalued currency. If a country like Germany were to leave, by contrast, the prospect of a much stronger currency would give an edge to shares of companies that import, such as retailers, or that do business in domestically focused industries like utilities.

The threat of economic and social dislocation from a fragmenting euro makes it very unlikely that European governments will allow it to happen, the study's authors reason. Instead of moving farther apart, euro zone members will draw closer through some shared fiscal policy, they predict.

They're probably right. A consistent feature of European integration is that it keeps happening, no matter what. As the creation of the euro itself shows, regardless of how boneheaded the idea is or how grim the outcome may be, Europe's leaders will enshrine it in a treaty several hundred pages long and in numerous languages. As for how to invest if you fear the worst, there really isn't a way, as UBS sees things:

"Our base case for the euro is that the monetary union will hold together, with some kind of fiscal confederation. . . . But what if the disaster scenario happens? How can investors invest if they believe in a break-up, however low the probability? The simple answer is that they cannot. Investing for a break-up scenario has [no] guaranteed winners within the euro area. The growth consequences are awful in any break-up scenario. The risk of civil disorder questions the rule of law and, as such, basic issues such as property rights. Even those countries that avoid internal strife and divisions will likely have to use administrative controls to avoid extreme positions in their markets. The only way to hedge against a euro break-up scenario is to own no euro assets at all."