Bond auctions across Europe indicate that interest rates on Italian and Spanish bonds are rising to unsustainable levels, and even German bonds (Bunds) are experiencing hiccups … (This is no longer just about Greece). A month ago, the demise of the euro was considered a long shot. Now it’s more a question of what can be done to save it.
Where is decisive leadership in Europe?
So far, the silence is deafening.
Much of the action taken by European authorities has been counter-productive. By making the Greek haircut to banks consensual (e.g. so that the haircut would not technically qualify as a “default”), so that owners of Greek Credit Default Swaps could not collect any insurance with respect to the Greek default, future investors in euro-denominated bonds (e.g. Spanish or Italian debt) would rather not take their chances (with or without CDS’s). If a 50 percent haircut is not a default, then what is?
This fiddling with rules has only served to increase the reluctance of investors or banks to lend to any European government, helping to increase borrowing costs across the European Union, at the worst possible time. A perfect example of how fiddling with the rules for self-serving advantage only serves to dig a deeper hole.
Now to translate the uncertainty surrounding the euro to the level of the man-in-the-street.
-
Will the euro cease to exist as a currency? If so, what will happen to contracts denominated in euro?
-
Will one or more economically weaker countries resign or be dropped from the euro zone, in which case there might be an even stronger “core” of euro zone countries? in such a scenario the Euro might even emerge as a stronger currency than today.
-
Unless dramatic action is taken to rescue the euro, if it does not cease to exist as a currency, it may become substantially weaker. This may create windfall profits and losses among parties to euro-denominated contracts. I, for example, have entered into a lease agreement with option to sell a house in euros. If the euro collapses, my lessee will only be too delighted to purchase the house in vastly depreciated euros. There are most likely millions of such contracts, both inside and outside the euro zone, which would create grief for the contracting party suffering from devaluation.
Bottom line: if the euro were to collapse in value, this is likely to create massive and unintended wealth transfers, creating windfall profits for some, and great difficulties for others.
In Central Europe, Slovenia and Slovakia were very fast to join the euro zone. Poland, Hungary and other Central European countries may be thankful that they did not immediately rush into the Euro. Under the above scenarios, having a local currency may provide degree of insulation from the Eurozone difficulties. Wouldn’t it be ironic if the zloty and the forint would become safe havens from euro-zone fallout?
The world waits with baited breath to see whether Germany and the wealthy members of the euro zone have enough at stake to depart from their strategy over the past few years of providing “too little, too late” in defence of the euro, and carry out a definitive last minute rescue of the euro, and to see what form such a rescue might take.
