Greece’s Withdrawal from the Eurozone Could Cause Global Economic Crisis
Bertelsmann Foundation warns of extensive domino effects
Greece’s exit from the Euro bears the risk of kindling a wildfire throughout Europe and possibly even on an international level and may result in a worldwide economic crisis. Countries affected would include not only Southern European nations or EU members, but also the USA, China and other emerging countries. This was the conclusion reached by a national economic assessment conducted by Prognos AG on behalf of the German Bertelsmann Foundation, which analyses the financial consequences and, for the first time, also possible declines in growth for Germany as well as for 42 of the most important industrial and emerging countries until the year 2020 in the wake of a departure from the Euro by Greece or other crisis-stricken countries. The scenario calculations present the authors of the study with some serious concerns.
For Greece, the scenario would involve national insolvency, a massive devaluation of the new Greek currency, unemployment, falls in demand and many other problems, effects that will quickly show their mark on its direct trading partners. In the Southern European country alone, the ensuing losses of growth would amount to 164 billion euros or 14,300 euros per person by the year 2020. The 42 top national economies in the world would already have had to absorb total losses amounting to 674 billion euros in total.
However, since it is not possible to eliminate the potentially massive ramifications that Greece’s exit from the Euro would entail for other Southern European crisis-ridden nations, the calculations were extended to include these scenarios. For example, in the event of the additional exit of Portugal from the Eurozone, this would mean a loss of 225 billion euros for Germany by 2020 and necessary debt write-offs of 99 billion euros. Globally accumulated losses in growth would add up to 2.4 trillion euros at this point, of which the USA would be hit with 365 and China with 275 billion euros respectively. With this scenario, per capita losses in income in Germany would total 2,790 euros over eight years.
“We must now be absolutely sure of preventing the conflagration from spreading in the current situation”, warns Aart De Geus, Chairman and CEO of the Bertelsmann Foundation’s Executive Board. The market uncertainties brought about by the Greek or Portuguese departures would harbour the danger of drastically increased risks for the already highly debt-burdened economies of Spain and Italy, so that a further erosion of the Eurozone would be inevitable. The European Solidarity Group would find it virtually impossible to deal with even the burdens incurred to the countries themselves by their departures, according to De Geus.
But the scenario would become even more dramatic if Spain’s exit were to be taken into the equation. If Spain were to leave the Eurozone as well, declines in growth in Germany would increase to 850 billion euros by 2020, with outstanding debts of 266 billion euros being waived. In the USA, it would mean a loss of growth to the extent of 1.2 trillion euros and in the 42 countries under review it would result in losses of 7.9 trillion euros. Even the accumulated per capita losses would soar upwards in this scenario. The result would be a loss of 10,500 euros per capita over eight years by 2020 for Germany, a loss of 3,700 euros in the USA and as much as 18,200 euros in France and 16,000 euros in Spain respectively.
The situation would spiral totally out of control if the Euro crisis were to reach the point where Italy would also have to leave the Eurozone: Germany would be giving up 1.7 trillion euros and would have to write off 455 billion euros. Here economic losses in Germany with more than 21,000 euros per capita would in some cases be even higher than in the exiting countries Greece with more than 15,000 euros, Portugal and Italy with nearly 17,000 euros as well as Spain’s 20,500 euros. The result would be increased unemployment for the population: the number of unemployed in Germany alone would rise to more than a million by the year 2015.
This scenario would eventually lead to a dramatic international recession and global economic crisis. By 2020, growth losses in the countries under review would reach a total of 17.2 trillion euros. In absolute terms, losses suffered would be the highest in France at this point (2.9 trillion euros), in the USA (2.8 trillion euros), in China (1.9 trillion euros) and in Germany with roughly 1.7 trillion euros.
In their overall appraisal, the authors arrived at the following conclusion: an initially isolated exit by Greece and its national insolvency may well be something that could be dealt with from an economic point of view, but the effect would be that the global economy would be thrust into a deep recession as their impact is difficult to calculate, and the recession would not stop even at economies outside Europe.
In addition to the purely economic consequences, considerable social tensions and political instabilities must be taken into account – primarily in the countries exiting from the European Union, but also in other economies. The danger of kindling a wildfire with all the economic and political consequences, as well as the social follow-on effects of a Greek national insolvency and exit from the Euro present a threat which the international community of states should attempt to prevent at any cost – even outside of Europe.
About the study: The calculations are based on Prognos AG’s econometric VIEW model, which is able to reproduce the national economies of 42 industrial and emerging economies on the basis of empirical data over an extensive period of time and in great detail. For comparison purposes, uniform exit assumptions or estimates were used to calculate the exit costs of the four countries. Thus, for all countries a debt average of 60 per cent was assumed for private as well as public debtors and a 50 per cent devaluation of the newly introduced currencies in the exit countries was compared with the euro.
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For any questions please contact:
Dr. Thieß Petersen
Tel. +49(0)52-41-81-81218 E-Mail: thiess.petersen(at)bertelsmann-stiftung.de
Dr. Ulrich Schoof
Tel. +49(0)52-41-81-81384 E-Mail: ulrich.schoof(at)bertelsmann-stiftung.de
I think there are two points worth making about this study. The first is that I wonder what would happen if one ran the same model over the period 1990 to the present, with no creation of the Euro and compared it with the actual data. I suspect that it would show that the existence of the Euro has imposed massive costs on many of the many member states and that there have been similar ramifications for the global economy. I suspect similar staggeringly large negative numbers could be generated. Hypothetically, if we were starting from the position just before the Euro came into existence, but had this data, it would surely be abandoned? Like the American tourist lost in the west of Ireland and asking for directions from a local, this is a bad place to start from. One we should never have been in.
Secondly, this study appears to have found every possible risk and included it. This is dishonest. No account is taken of the deeply depressing impact the Euro is having and will continue to have on consumers, business investment, government spending and financial markets which seem to sense impending doom. I recall well the collapse of the insane ERM in 1992. Those who had nailed their political future, not to mention their shirts, to the ERM said all the same things. If it collapsed, there would be dire consequences. I watched this at close range in the UK and listened to all this doom and gloom. In fact, once the thing fell over, everything immediately started to get better. Exactly the opposite of what the politicians and other “experts” said would happen, happened. The minute their policies failed everything improved. In fact, the UK went on to experience the longest ever period of uninterrupted growth. As if the catastrophic consequences of the ERM weren’t enough, the Europhiles came up with the Euro, surely an even more insane idea.
Although 1931 was not an event I observed close up, something similar happened. The gold standard, deemed so important to the world economy was clearly acting as huge, depressing, deflationary force. Similarly, the minute it fell over, everything got better. I remember at first hand again, the 1967 devaluation of sterling. Similar tales of woe and the end of the world that threatened did not occur. As a matter of fact, the huge fiscal deflation that accompanied the devaluation meant that the UK economy stagnated but the claimed horrors of the devaluation did not occur. In policy terms, the devaluation worked, despite falling employment in the short run.
It is my guess that the trauma of a Greek exit and maybe followed by others would at least get rid of the sense of impending doom. This sense of impending doom seems to be ubiquitous except amongst those directly involved in Euro institutions. I have no doubt that the consequences for Greece would be grave indeed. I think the report is right to focus attention on that. Some sort of special measures need to be taken to support Greece in this event. Some sort of modern Marshall Plan. But the idea that the world would be thrust into depression is difficult to believe. There would be a serious need to sort out the problems of the Eurozone and new wave of pressure to do so. I suspect that within 5 years things would have improved almost everywhere and we would be left wondering what all the fuss was about. It really is difficult to see how Spain and Italy could possibly be doing worse outside the Euro than within it. And it is difficult to see how even Germany can afford to continue with the present crisis/bailout cycle.
Late but hopefully not too late three notes on this comment:
Economic development without the Euro: I think that the entire Eurozone had economic benefits from the introduction of the Euro, at least until 2010. The Euro reduced transaction costs and hedging cost within the Eurozone, it increased the intra-Eurozone trade, and the low interest rate boosted private consumption and private investment. Thus the Euro increased economic growth and employment within the Eurozone. This thesis is confirmed by a study of McKinsey Germany published at the beginning of this year (http://www.mckinsey.de/downloads/presse/2012/The%20future%20of%20the%20euro_McKinsey%20report.pdf). According to these calculations the GDP of the Eurozone would have been 330 billion Euros lower in 2010 if we had not introduced the euro.
Included risks: The risks included in this study are limited. We are asking: What could happen if IMF and others stop their financial support of Greece? In that case Greece would face sovereign default. In order to be able to pay government employees and other entitlements Greek government needs to introduce a new currency and thus leave the Eurozone. This development (sovereign default and introduction of a new currency) might have various economic consequences. The study revealed its underlying assumptions: A 60 per cent haircut for private as well as public creditors, a 50 per cent devaluation of the newly introduced currency and a reduction of private consumption and investment in the exiting country by ten per cent in the first year and five per cent in the second year. Many of these assumptions are derived from historical experience such as Argentina 2001/2002. Other possible consequences such as a European or even global credit crunch or plunging stock prices are not included in the study (Lehman crisis had these consequences). I wouldn’t call this proceeding ‘dishonest’. And the simulated possible – but by no means necessarily – wave of further Eurozone exits is a possible scenario shared by many others.
Positive consequences of the devaluation of the new currency: The devaluation of the new Greek currency will have a positive impact on economic competitiveness immediately. But at the same time it is quite reasonable to assume that the sovereign default and the introduction of a new currency will cause a general loss of confidence in Greece and thus lead to a reduction of private consumption and private investment (see the example of Argentina in 2001/2002). According to the results of the study the loss of confidence will predominate during the first four years and thus cause an economic slump in Greece.