Can you unscramble an omelet? That, in essence, is what euro zone leaders and the global monetary policy elite will have to do if the euro zone is to be reshaped in any semblance of an orderly manner, be it by letting Greece go or creating an inner hard core and an outer soft one.
Just how difficult this could be can be gleaned from an unusual quarter. Lord Wolfson, a UK euro sceptic, has offered a £250,000 [$394,000] price for anyone coming up with a plan to unwind the euro zone in a non-chaotic fashion. Not the kind of money you throw around if the answer is obvious.
The potential danger of a breakup, both to euro zone economies and the global financial system, is so great that it is often cited as a reason it will never happen.
Nonetheless, the idea that the euro zone might break up — or at least redesign itself — is no longer just the province of critics who thought it was a bad idea in the first place.
Greece’s removal from the currency bloc is the main talking point. Although European Union leaders have rallied around to say publicly it cannot happen, Euro group head Jean-Claude Juncker has couched his support by saying that Greece cannot stay in the euro zone at any price.
French President Nicholas Sarkozy, meanwhile, has raised the idea that some euro zone countries should accelerate and deepen their integration, while a wider and expanding group outside the currency bloc stays more loosely connected.
This, at one stage, would have bordered on euro zone heresy given the official line that all European Union countries should be members and integrate. It may not be what Sarkozy meant, but it raised the old specter of a northern and southern euro.
The problem is that barely anyone believes that any kind of re-configuration can be achieved without destroying public confidence, prompting investor flight and hitting financial institutions as hard, or more so, than the Lehman Brothers collapse in 2008.
If you knew your euros were about to be switched to, say, new drachmas or an untested currency called the Seuro, would you leave them where they were?
“I don’t think there is a peaceful solution to their problem,” said Andrew Clare, professor of asset management at Cass Business School in London. “The real problem is the potential runs on banks.”
Given European banks’ exposure to the likes of Italy and Greece, confidence in the financial system could easily collapse across the currency bloc and beyond. Bank runs would not be confined to those countries at the center of the debt crisis.
At the heart of the issue, at least practically, is that no contingency was ever made for either the euro zone to fail or for any country to drop out of it.
“It was a taboo to think about it. The whole idea from the beginning was that monetary union is forever,” said one European Union monetary official involved in the euro’s launch during the 1990s.
The Germans even had a word for it: Schicksalsgemeinschaft. Literally meaning fate community, it was used to give the idea that creating the euro was something that could not be put asunder.
Over time, little appears to have changed. A 2009 paper drafted by the European Central Bank looked at the legal implications of the withdrawal or expulsion of a country from the euro zone, but did not give any suggestions about how.
This is one reason why many economists and investors still consider a break up — certainly beyond a contained removal of Greece — to be a “tail risk”, something that could happen, but is not part of a consensus scenario.
When Europe’s leaders and policymakers are staring right into the abyss, the central assumption is that they will overcome their principled objections and do what is necessary to save the euro. That would almost certainly involve a much more active European Central Bank.
UBS said on Tuesday it still believed that when push came to shove Germany would step back from its hard line and allow the ECB free rein to fix the debt problem.
“The most likely change will be the ECB, and we all think that eventually the Germans are going to capitulate and allow the ECB license to print money and expand the balance sheet even further, (and) allow higher inflation in the euro zone,” said George Magnus, the bank’s senior economic adviser.
IN THE DARK OF NIGHT
Although there seems no way that any break up or casting off of members could be done without massive disruption to the financial system, it is possible that some things could be done to mitigate the reaction.
“You can minimize the damage, but you have to do it fast and unsuspected,” said Holger Schmieding, chief economist at Germany’s private bank Berenberg.
The idea, he said, would be that if Greece were to leave the euro, capital controls would need to be imposed without warning to stop runs on banks. It would also need to happen in a way that did not imply to markets that more was to come.
“Everything would have to be done overnight in such a way that everybody believes you will never do it again,” he said.
If anything leaked in advance, chaos would ensue and even if it did not, it is not clear how such secrecy would play with financial markets and how you would persuade people that the same thing would not happen to the next country along the debt domino line.
“The issue is whether markets would agree that Greece would be the only one,” said Schmieding. “Possibly you can find out that you can minimize the chaos, but this is a risk I would not want to run.”
(Additional reporting by Mike Dolan and William James, Editing by Mike Peacock)