Saturday, November 12, 2011

What happens when the Eurozone breaks-up?


Word out of Brussels is that Germany and France are in preliminary discussions over how a break-up of the Eurozone would take place and look!

And as we know, political rhetoric aside, perception becomes reality.

With Italy 10-year government bond yields hitting as high as 7.5% last week and the rest of the EU PIIGS led by Greece teetering on the edge, the reality is that the politically engineered financial and social experiment known as the EU is in some serious trouble.

This trouble within the EU, were it to spiral further out of control and lead to a Eurozone collapse, has the potential to take the rest of the world down with it!

So what happens when the Eurozone breaks-up?

From The Economist by way of The Guardian comes this Q&A of the potential ifs, hows and whens were the EU to break-up, or at the very least kick the weaker sisters out!

I am providing number 8 of the questions and answers, and for 1 through 17 visit The Guardian here.

"8. What would be the impact on global financial markets?

Again, this would depend on the nature and scale of the break-up, but it would certainly be negative for equities and other risk assets, resulting in flight to safety on a potentially epic scale. Stock markets would fall dramatically in most countries. Although investors have already priced in substantial negative expectations, a euro break-up would have a much more dramatic impact on confidence.

Government bond markets would probably be split between those seen as relative safe havens and the rest. US bond yields could fall even further as investors piled into the “risk off” trade. German bunds could also benefit similarly, although this would depend on market perceptions of Germany’s success in isolating itself from weaker euro members. As in the aftermath of the collapse of Lehman Brothers in 2008, dislocations in the short-term markets that lubricate the global financial system would emerge. In Europe, the impact of break-up would probably surpass the turmoil seen in the wake of Lehman’s collapse.

The potential fallout elsewhere in the world is difficult to judge, but with each new country that left the monetary union, the impact would become more severe. For example, departure and default by Italy—the world’s third-largest government bond issuer, with bonds worth about US$2.1trn in circulation—would immediately imperil the solvency of financial services companies across the world.

Those that could not raise sufficient funds to compensate—a foreseeable problem given that liquidity would be tight—would have to turn to governments for support. The resultant market turmoil could be exacerbated by limited capacity for states to support the financial sector on a similar scale to that in 2008-09."

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