UBS Tries To Quantify Euro Break-Up

by: James A. Kostohryz
UBS has tried to beat its competitors to the punch today by publishing some estimates quantifying what it believes could be the cost of a euro break-up.
The estimates are rather vague and are not well supported within the text. Having said that, I think that the estimates are not unrealistic. The reason is that the losses projected in the first year are of a magnitude that is similar, in terms of GDP, to the total losses experienced in banking crises in Asia and Latin America during the 1990s. The total multi-year losses in the euro area should ultimately be worse due to the tight integration of euro-area economic and financial institutions.
Here are the highlights of the report:
The economic cost to “weak” countries. 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 to “strong” countries. Were a stronger country such as Germany to leave the euro, the consequences would include corporate default, recapitalization 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.
The political cost. The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the euro would incur political costs. Europe’s “soft power” influence internationally would cease (as the concept of “Europe” as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.
I do not think that the precise estimates provided by UBS are that important. I think that what is significant about this report is that it may kick off a wave of speculation around the world regarding the cataclysmic consequences of a break-up of the euro. It would not be surprising if analysts start falling over themselves trying to one-up the prior analysts with even bigger loss estimates.
Such speculation could fuel further downside on indices such as the DAX (^GDAXI), CAC 40 (^FCHI) S&P 500 (^SPX) Dow (^DJIA) and Nasdaq 100 (^NDX). ETFs such as EWG, EWQ, SPY, DIA and QQQ would fall proportionately. Anchor stocks for those indices and ETFs such as Siemens (SI), SAP (NYSE:SAP), Deutsche Bank (NYSE:DB), France Telecom (FTE), Sony (NYSE:SNY), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), IBM (NYSE:IBM) and Intel (NASDAQ:INTC) could also be affected.
As reported here, the technology sector in the U.S. could be particularly affected by turmoil in Europe given the high percentage of sales to Europe in this sector.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long SPX puts.