This is going to get a lot of buzz...

UBS' Stephane Deo, Paul Donovan, and Larry Hatheway have released a monster report (posted over at ZeroHedge) examining the consequences of a Euro breakup, a once unlikely-seeming outcome that now grows more likely by the day.

The first line basically nails it:

The Euro should not exist (like this)

Under the current structure and with the current membership, the Euro does not work. Either the current structure will have to change, or the current membership will have to change.

The report argues that basically the whole system, right from the start, was basically a lie:

Why consider break-up at all? Break-up occurs because the Euro does not work. Member states would be economically better off if they had never joined. European monetary union was generally mis-sold to the population of the Europe. In the 1990s the Euro was often characterised as an instance of foreign exchange rate integration – the Exchange Rate Mechanism without the crises. The advantages of no foreign exchange rate uncertainties or costs for trade and tourists were emphasised. Of course the exchange rate integration was probably the least of the consequences of the Euro. The most important consequence was the integration of monetary policy. The hint was in the name “European Monetary Union”. However, politicians sought to ignore that hint. A Euro that had been promoted on the idea of monetary union rather than exchange rate integration would have been far more difficult to sell to the electorate.



A monetary union is, economically speaking, a “good” idea if the membership constitutes an optimal currency area. This occurs under one of two conditions. Either the area is so homogenous that the component economies all move in the same direction at roughly the same speed, at the same time. Alternatively, the economies are sufficiently flexible that any differences in economic performance can be relatively swiftly corrected.

Ultimately, even at this dire moment, UBS still has a hard time seeing a breakup, calling some kind of fiscal union more likely. The major reason: It would just be too economically costly for anyone to depart.

The economic cost (part 1)

The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around EUR9,500 to EUR11,500 per person in the exiting country during the first year. That cost would then probably amount to EUR3,000 to EUR4,000 per person

per year over subsequent years. That equates to a range of 40% to 50% of GDP in

the first year.



The economic cost (part 2)

Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP 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 EUR1,000 per person, in a single hit.

Read more, including a discussion of breakup mechanics, at ZeroHedge >