Six triggers for break up of the euro

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June 29, 2011, 8:38 a.m. EDT

Six triggers for break up of the euro

Commentary: How to survive the coming end of the euro zone

By Matthew Lynn

LONDON (MarketWatch) — If you look hard enough, you can still find a few people who believe the euro can stagger on with all the 17 members it has now on board. The president of the European Union, Herman Van Rompuy perhaps. And Jean-Claude Trichet, the president of the European Central Bank. Possibly the editorial writers at The Financial Times as well.

Just about everyone else, however, thinks the Greeks will break away eventually — and quite a lot of people think the whole project will implode before the decade is out.

But you can’t start a war without somebody firing the first shot. And you can’t break up the euro zone without a trigger.

The way that the euro single currency /quotes/zigman/4867933/sampled EURUSD +0.1415% comes apart matters a lot — both to the stability of Europe, and to the financial markets. So what are the potential flash points for the euro breaking apart? It won’t be something that everyone expects. That’s not the way things work. It will be a ‘black swan’ — an event or crisis that no one has been thinking about, or worrying about.

Here are six to keep an eye on — and their likely financial consequences.

One: A military coup in Greece — or indeed Portugal. These are both countries that were still under military rule when the Beatles released “Let It Be.” The army taking charge is part of their very recent past — and the military has often seen itself as the saviour of the country in moments of crisis. Could it happen again? If Greece were to go back to the drachma, probably the best way of doing it would be for the military to seize power, cancel its foreign debts, introduce capital controls, start printing money, and get tough on law and order for a few very hard years. But the sight of tanks on the streets of an EU member state would also create chaos on the financial markets, with the euro and stocks plunging in value.

Two: The German constitutional court rules the bail-outs illegal. There are a series of cases due to be heard by the country’s top judges. Both the Greek bailout and the new European Financial Stability Fund could be ruled illegal — Morgan Stanley rates it one of the risks to the rescue packages, although judges it unlikely. What if it happened, however? The German government can no more ignore its own constitution than the U.S. government can. The best solution in those circumstances would be for Germany to find a way of handing over some money temporarily — and then start negotiating its own exit from the euro, accompanied no doubt by massive aid for the periphery. That would be a sensible solution to the crisis — and paradoxically, the euro and the stock market would strengthen on the news.

Three: Marine Le Pen makes the run-off in the French presidential election. The euro zone hasn’t yet seen a major political force campaigning for withdrawal from the single currency. Even in Greece, the street protestors might shout about it, but the political class still refuses to countenance the idea. But the far-right French leader Marine Le Pen wants to bring back the French franc. If she beats Nicolas Sarkozy to make the run-off in next year’s presidential election — and some of the polls have shown her neck-and-neck with the incumbent — she’ll put the issue right on the agenda. The French voters, unlike their leaders, have always been skeptical about the euro. A president could get elected from the right or left committed to pulling out of the euro. The markets will panic, and French bonds and stocks will tank — making withdrawal even more likely.

Four: The International Monetary Fund ends the bail-out game. The IMF is now devoting the bulk of its resources and energy to rescuing the euro zone, even though all its members are relatively rich compared to other countries around the world. But the Americans, Australians, Japanese, Koreans and so on don’t really have a dog in this fight. Why should they pay good money to sort out a mess that other people have made, and don’t show much sign of fixing? Sooner or later they will insist the IMF scales back its support. Even with France’s Christine Lagarde in charge, those calls may be impossible to resist. What happens then? Without IMF support, the bail outs can’t continue. Everyone will have to negotiate an orderly default and break up. On that, the currency will weaken, but stocks will rise.

Five: The Chinese pull the plug. China has emerged as one of the major buyers of euro-zone debt in the last year. No one can quite figure out what game it is playing in keeping the euro afloat. Perhaps it needs to keep its export machine going — Europe is just as important a market for China as the U.S. Maybe it is just diversifying from T-Bills? But if it pulls the plug, the game is up. Europe’s sovereign-debt market can’t withstand a sudden withdrawal of support. In truth, the euro zone has become dangerously reliant on an unreliable partner, with mysterious motives. If the Chinese pull out, European bonds will collapse in value — but so will T-Bills as investors fear they are next.

Six: An Italian banking collapse . So far, Italy has been the dog that hasn’t barked in this crisis. It has sailed right under the radar. But the country has massive debts, and non-existent growth. There was a brief panic last week when trading in some of the Italian banks was suspended in Milan. All it would take would be a wobble from one of the Italian banks to precipitate a wider banking crisis, first in Europe, and then globally. It would be the “Lehman moment” that everyone in the markets fears. On that scenario, you’d want to avoid any financial stocks. But you’d want to own the Swiss franc and gold.

No one can really say where this crisis will end, anymore than they could predict that Soviet communism would collapse in Berlin in November 1989. What you can say is that the euro will come apart some time in the next five years – and those six flash points are the ones that investors should be focussing on.


Matthew Lynn is a financial journalist based in London. He is the author of "Bust: Greece, the Euro and the Sovereign Debt Crisis," and he writes adventure thrillers under the name Matt Lynn.

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