The Euro will survive, but not the current Euro zone !

If the existence of the euro is not challenged, it is the case of the euro zone in its current configuration. In the same way that cohabitation between countries with maintaining parity exchange had become impossible in the EMS, cohabitation has become impossible within EMU between the model of economic specialization of industrial countries in northern Europe and the Southern Europe

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In a paper written in late last year, we explained that the probability of a collapse of the euro area lost intensity

Regardless of the situation of fragile countries on which we will return, it is always difficult to anticipate a unilateral exit for Germany for at least two reasons :

The Euro will survive In fine !

We do not believe or at least most of the implosion scenarios of the euro zone regardless of the terms. -Not because we would be trying to find one or several sustainable solutions to the crisis of sovereign debt, but because such a process would cost too much to everybody(...)

-1/ high macroeconomic cost with a considerable loss of competitiveness related to the introduction of a new mark sharply revalued against the euro (although German exports are relatively inelastic in the currency appreciation due to the high quality of certain products, there is probably a level of reassessment of exchange parity which can pose a real problem of competitiveness);
-2/ a high financial cost associated with the commitments of German banks on the peripheral countries of the Euro zone

Indeed, we are not in the economic and financial environment of the 1990s when the appreciation of the mark against the franc, lira, peseta, escudo had no strong consequences on the German economic and financial system as they are today.

Yet there is a more or less explicit debate in Germany about the benefits and / or disadvantages of the cost of exit compared to the cost of the rescue of several countries. Nobody really knows today what is the most expensive solution because the whole problem is to know (and we will return to that) if the rescued country can come back to solvency position over the medium term following the introduction of unconventional public devices (EU-IMF-EFSF), private (write-off of banks, insurers and other institutional investors) and the establishment of conjuring tricks of the European Central Bank. If so, Germany could not consider an implosion of the Euro zone, or it may be advantageous to consider a reconfiguration of the Euro zone

At the end of 2011 for example, the German banks balance sheet exposure to the sovereign debt of Spain, Italy, Portugal and Greece was assessed by the European Banking Authority to nearly € 67 billion, the same exposure was € 37 billion for the largest German insurer. These data are important for anyone looking to make simulations on the cost a German exit from the Euro zone with necessary recapitalization of its banks, insurers (due to massive losses from exchange rate risk and thus more or less explicit defaults of certain peripheral debts) versus the solution of further bailouts with impacts on German public finances.


Anticipating the future of our Euro zone, it is also the question of the optimal functioning of a currency area or monetary union

We remember 20 years ago (June 1992-July 1993), the EMS could no longer function. He became, indeed, unsustainable to fight against German inflation born of German reunification of 1990 (requiring higher interest rates) and fight against unemployment in the French and South European countries economies (with key rates raised by central banks in these countries to prevent their national currencies from dropping vis-à-vis the mark). The "parade" was found in July 1993 with a widening of the fluctuation margins between the currencies of + / - 2.25% to + / - 15%. But meanwhile, Italy, Spain, Portugal and Ireland - yes them already - came out of the European Monetary System. What would have happened if at that time instead of having a monetary system with quasi-fixed exchange rates between currencies, we had a monetary union with single currency? Well this is what happens today and since the markets could not "attack" the currencies of countries considered fragile, they would attack the assets correlated with economic and fiscal health of these states, having public debt with large spreads vis à vis the German Bund.

In the same way that cohabitation between countries with maintaining parity exchange had become impossible in the EMS, cohabitation has become impossible within EMU between the model of economic specialization of industrial countries in northern Europe and the Southern Europe (including France) based on the often non-tradable services.
Mory Doré

But in the same way that cohabitation between countries with maintaining parity exchange had become impossible in the EMS, cohabitation has become impossible within EMU between the model of economic specialization of industrial countries in northern Europe and that of Southern Europe (including France) based on the often non-tradable services. That is to note that structurally, while the countries of "North" only increase their external surpluses (and reinvest more in government securities in the southern countries), countries of the "South" are increasing their deficits (and then struggling to refinance). Without the ECB, the EFSF and the IMF, the euro zone - at least in its current configuration - would no longer exist.

So it is one of two things and only one:

  • Either we move to a fiscal union and a federal budget that will institutionalize fiscal transfers from North to South. Which case the heterogeneous economies is no longer a problem. But for such a solution is acceptable especially for Germany, this adds up to trusteeship budget of countries such as Greece (which is almost already done whatever it may say), Portugal, Italy , Spain and perhaps France tomorrow. Suffice to say that it is politically impossible
  • Or we can set up this budget union and we must create the conditions for homogenization of the economies based on what you consider to be like the model, Germany. Besides the fact that it would be very lengthy and costly socially to reindustrialize even to industrialize some economies from the South, this solution is not necessarily an economically optimal solution. Because after all if all economies of the euro zone had looked like Germany with a strong corporate profitability and competitiveness conditions combined with high costs generated by containment policies of the payroll, then each country of the euro zone would have been able to take market share to another, in other words, one would have quickly found a kind of non cooperative macroeconomic equilibrium and therefore a zero-sum economic game. The only possibility for this configuration to be economically efficient had been that the euro zone in this case could take market share to the rest of the world, which may seem totally illusory considering the differential of competitiveness with emerging economies ( excepted a very strong appreciation of EM currencies vis-à-vis the euro or European fiscal policy with zero-rating tax on labor costs, therefore very high taxation of consumption). So in total, this solution seems to be socially and economically impossible


We bet on the continued existence of the euro but at the cost of a very sharp depreciation of the euro against other currencies including the dollar. Despite the ultra accommodative monetary policy the Fed announced with the maintenance of interest rates near zero until the end of 2014 (and probably beyond) and perhaps new forms of quantitative easing to come, the dollar will no more depreciate against the euro. Because that is not often told, the U.S. political and monetary authorities are beginning to understand that the need for a "low" dollar is less and less significant to boost economic growth.

History will teach us with no doubt that it probably would have been better to trigger a credit event on Greek debt. Regardless of the financial benefit that a particular hedge fund might have derived in the short term, the problem being more strategic than that.
Mory Doré

In a recent study of Natixis, Patrick Artus shows that the energy model of the U.S. economy is based on a dependence less strong vis-à-vis oil and relies increasingly on the production of shale gas . The consequences are important : the price of natural gas being uncorrelated with oil prices, the U.S. again become very competitive compared to Japan and Europe since the relatively low gas prices are equivalent to a decrease in labor costs of 6% in the industry vis-à-vis Japan and 12% vis-à-vis the euro Zone

On the other side the euro zone has no choice but to resign themselves to a weak euro or very low (the 1.05 to 1.10 area remains a realistic goal for us to end of 2012 - spring 2013) to offset fiscal and tax policies which will become increasingly restrictive for the entire area

  • Fiscal Policy moderately restrictive for virtuous countries such as Germany, the Netherlands and Finland
  • Very restrictive for countries such as France, Spain and Italy if they remain in the union - what we continue to believe-
  • Finally restrictive over time for countries like Greece and possibly Portugal, which would leave the country but with a new monetary status tied to the Euro (new devalued exchange rate against the euro but with a central rate and fluctuation bands of + / - 5% or 10%)
    Central Banks : the global financial system trashcans ?

    Institutionalized monetization condemns central banks to become the international financial system trashcans and, despite German opposition, it is likely to be the same for the ECB.

We are anyway heading towards institutionalized monetization of the ECB (directly or rather indirectly by refinancing a European Stability Mechanism, successor of the EFSF and antechamber of a true future European Monetary Fund). But for this monetization to be effective, it must only concern countries in liquidity crisis. We think of Spain and Italy if the markets re-propelled 10-year rates of these countries respectively above 6% and 7%, but one should not exclude France if the outcome of fiscal policy polls in May 2012 was -rightly or wrongly - deemed not credible by investors and rating agencies. This institutionalized monetization could not and should not involve countries with a real solvency crisis (Type of Greece and Portugal).


Since Greece is insolvent, the bailouts, which turn to psychodrama for nearly two years are of no use.

Why persisting politically while virtually "everyone" knows. Some for long time indeed

The Greek crisis : the Danaides’ barrel ?

Back on the Greek saga or the largest bankruptcy in the 21st century without credit event trigger (to date). The succession of bailout plans shows that we do not simply resolve the insolvency of a country by emergency(...)

  • From 2000-2002 those who have disguised the public accounts of the country know.
  • Since 2009 some market observers reassessing the consequences of the financial crisis on global growth and the prospects for countries with low growth potential know.
  • Since May 2010 with the first bailout, institutional investors are in doubt
  • Since 2011 and with the successive plans, the general public knows.

So if the existence of the euro is not challenged, that of the euro zone in its current configuration is. Our central scenario is as follows

  • "Temporary" exit of insolvent countries thus forcing them to devalue their new currencies and therefore default on their foreign debts (Greece and Portugal). From an institutional point of view this situation take the form of a specific monetary status linked to the euro for these ex-EMU countries (new devalued exchange rate against the euro but with a central rate and fluctuation margins of + / - 5% or 10%). From an economic standpoint, one can imagine that economic devices revitalization are in place to bring back to solvency for good in the medium term these economies: tax free zones and adapted to foreign industrialists (Euro zone as emerging regions) . Conditions for success: a / include fiscal discipline over time ; b / maintenance of accommodative monetary conditions to compensate for budgetary rigor: significant devaluation of the new national currency against the euro at the exit of the zone and short-term rates remaining low over a long period of time by the national central bank c ; / benefit to not delay in implementing real structural reforms (including the working of the public sphere in Greece)
  • A preservation in the Euro zone for political reasons (and especially because systemic risks would be significantly greater than in the case of "small" countries insolvent) of countries with fragile creditworthiness such as France, Italy and Spain. Taking the example of France, we are from a macro-economic point of view in a situation close to some ailing economies of Southern Europe: deindustrialization, no increase of our productions, so structural trade deficit and inability to reduce debt coming from trade imbalances ... But no one can imagine a virtuous Northern Euro zone with Germany as a leader and the Euro zone in the south lacking competitiveness with France as a leader ? It would be politically unthinkable since it would separate the six founders of Europe during the implementation of the Treaty of Rome in 1957: Germany and the Benelux countries on the one hand, France and Italy on the other . In any case, these countries could not devaluate their currencies without despoiling foreign creditors of their debts because these countries will keep the euro as currency; for cons they will eventually use the inflation tax to despoil their domestic creditors. Anyway, all this will end in high inflation. Especially since the emerging countries will pass on inflation instead of disinflation to western countries (required by the change of business model)


What one was and is entitled to expect from the political authorities can be summarized in 3 main principles:

Politics and financial markets: misunderstandings that are not new

Small point into the complex and tumultuous relations, misunderstood, between financial markets and politics. In these troubled times where the markets are supposedly expecting clear answers from politics and where at the same time, the same markets are accused of(...)

1/ Admit insolvency of certain countries and help create more viable conditions for solvency : tax, profitability, competitiveness, fiscal reform ... rather than the austere accountancy driving us to death?

2/ therefore Admit a formal default under the ISDA. Let’s Recall the scenario according to the ISDA itself triggering a credit event: Repudiation and the moratorium on debt (the most radical solution which was that of Russia in 1998) - The restructuring or rescheduling ( Argentina 2001) - Bankruptcy (this applies to banks and companies such as Enron in 2001, Worldcom 2002, Northern Rock in 2007, Lehman 2008) - Failure to pay called selective with inability to pay on time.

So far, everyone has judged positive to consider that we could not handle the situation in Greece in 2011 and again in 2012 as the insolvencies of 10 years ago. -Because the authorities are often overwhelmed by increasing sophistication and complexity of financial instruments; also overwhelmed by globalization that they favored, and by interactions between the various financial market participants. So, the permanent sword of Damocles to see happen a potential systemic crisis arose.

History will teach us with no doubt that it probably would have been better to trigger a credit event on Greek debt. Regardless of the financial benefit that a particular hedge fund might have derived in the short term, the problem being more strategic than that After all, outstanding Greek CDS was evaluated in September 2011 around 55 billion euros in gross (longs + short positions) for a debt of 350 billion Euros (before the surrender of the private sector) and we speak today of a net which would focus on the compensation of less than 3 billion Euros. Markets and investors, even if they do not fully realize today will recover easily from the inability of political and economic authorities to acknowledge the obvious

How do you or can you trust when those who bought insurances against an adverse event cannot exercise them when it occurs? And then prevent the onset of CDS legitimating the bankruptcy of Greece will hurt many financial assets at maturity (sovereign debt or not) if the derivatives products that can cover all or part of their adverse market developments are useless?

Mory Doré March 2012

Article also available in : English EN | français FR




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