The End-game for the Euro:
Three Unattractive Options
CEA Meetings
June 2012
Glen Hodgson
Senior Vice-President and Chief Economist
[email protected]
www.conferenceboard.ca
Overview
•  There is no easy end-game for the euro
•  Structural action finally being take, but far
too late
•  Option One: “more of the same”
•  Option Two: Greece leaves the euro
•  Option Three: Germany leaves the euro
•  All three options come with a heavy cost
•  A “made-in-Europe” solution required
www.conferenceboard.ca
Euro-zone Stabilization to Date
•  Established a common bailout fund of around €1 trillion total
(but not fully funded);
•  Begun to build a common fiscal foundation;
•  Finally used the lending powers of the European Central
Bank (ECB) to shore up the EU banking system, to roll over
and finance EU government bonds (although not until the
end of 2011);
•  Thrown a financial lifeline to Greece as part of the
adjustment agreement.
•  EU needs to refinance €1.1 trillion in 2012, plus find added
funding for fiscal deficits
www.conferenceboard.ca
Option 1: Continue with the Status Quo
•  Option One: “more of the same”
•  Refinancing of the public debt of key heavily
indebted countries
•  Additional ECB intervention to shore up the
banking system as required
•  Tough fiscal policy and reductions in wages
and benefits in order to improve
competitiveness.
www.conferenceboard.ca
Prospects for Option 1
Option 1 could work if the eurozone…
•  Gets through deep recession in key countries and see
growth emerge again in 2013;
•  Finds financial resources needed to prevent a default
in a heavily indebted country;
•  Eliminates fiscal imbalances in a realistic timeframe,
and keep making their debt payments on time;
•  Fosters adequate economic growth to reduce
unemployment; and
•  Begins to reduce public debt relative to GDP in key
countries.
Probability: under 50 per cent and falling
www.conferenceboard.ca
Option 2: Greece Leaves
•  Option Two would see Greece, the most
severely indebted case, leave the eurozone
•  Because there is no defined mechanism for
leaving the eurozone, this option would be
messy
www.conferenceboard.ca
Prospects for Option 2
•  More painful for Greece in the near term
•  Largely cut off from external credit and would have to
balance its fiscal books overnight
•  Massive challenge to recreate its own currency quickly
•  Banking system in turmoil
•  Could face other EU trade and political sanctions
•  Upside: would create the opportunity to improve
international competitiveness quickly through sharp
currency devaluation
Probability: over 50 per cent and rising
www.conferenceboard.ca
Option 3: Germany Leaves
•  Germany leaves the eurozone to re-create its own
currency, perhaps with a few others
•  Germany would incur all of the adjustment costs of recreating a separate currency, adapting to currency
appreciation
•  Germany would still have strong financial incentive to be in
future eurozone bailouts
•  Countries remaining in the eurozone would benefit from a
currency that depreciates in value
•  These countries would keep servicing public debt in euros
www.conferenceboard.ca
Prospects for Option 3
•  Most attractive option economically, but little
chance politically
•  Runs entirely counter to deep political
commitment to an integrated and unified
Europe
Probability: less than 5 per cent
www.conferenceboard.ca
Implications for Canada
•  This is not Canada’s problem to solve
•  Options 2 and 3 could be more attractive than the current
strategy of muddling along -- greater clarity and certainty
•  Option 2 may increase the willingness of other heavily
indebted eurozone members to stick with their adjustment
program
•  Canada should focus on:
•  pushing eurozone members to find a sustainable solution
•  Ensuring the Canadian economy can withstand any further
shocks
•  Pressing on with free trade negotiations with the EU
www.conferenceboard.ca
Visit us at
www.conferenceboard.ca
www.conferenceboard.ca