Don’t fear the euro breakup
September 2nd, 2011
Shell-shocked investors naturally jump at sudden noises, and the euro blowup will be a loud one. (Is the blowup inevitable? I argue yes.)
The longer-term economic consequences of a currency breakup affecting 600m people will likely be bigger than that of a few failed investment banks. Yet, when the day finally comes that we wake to learn France and Germany have let the Mediterranean nations swing, we Americans may face no threat of US financial collapse on the scale of 2008, for the following reasons.
- US firms are better prepared now. The financial system and indeed most public companies at least appear better capitalized than in 2008, and exposure to the euro is likely well anticipated. Our case for inevitable breakup (previous post) is not simple, but certainly not rocket science, and the collapse is happening slowly and in the open. So we suspect there has been adequate time for financial firms (outside Europe, at least) to limit the damage. In contrast, Lehman came as a surprise, because all banks had presumed the U.S. Treasury understood their interlocking exposure well enough never to permit an outright bankruptcy; anticipating rescue instead of bankruptcy, other banks never guarded against the prospect of cascading failure.
- Thanks to our newfound collective sensitivity to loud noises, the breakup is also better anticipated by investors, and thus better incorporated into price. Shares are already much cheaper relative to earnings than they were then.
- Because the euro is not the global reserve currency, a crisis may be more geographically contained.
- The US Treasury and the Fed have been on full alert now for three years. Again, Lehman was more of a surprise, requiring more time to put together a policy response. Not so here. The Fed stands ready, firehose of cash in hand, ready to extinguish the faintest wisp of smoke. Presumably it will step in instantly to rescue systemically important domestic firms that failed to manage euro risk. Short-term credit then remains intact, and we settle into an orderly global recession.
None of this is to say that it won’t be bad; but not, perhaps, as bad as we think.
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