In a new paper entitled "European meltdown?", the world's second biggest bank said Italy, Germany, and Holland had all been damaged by the perverse effect of the one-size-fits-all interest rate policy, and might be tempted to leave.It may be true that some countries could do better without the Euro. But the common currency is direly needed to keep Europe competitive in financial markets as the sheer size of the Euro market lessens the danger of an all-out attack on it. No currency of a single country was able to withstand the attacks in the 1990's. It has also to be remembered that the Euro led to a convergence of bond spreads, effectively reducing borrowing costs of most member countries as yield converged towards the German benchmarks. Smaller currencies are easy prey for speculative attacks which lead to the suffering of whole nations.
It said the euro had pushed Germany to the brink of deflationary spiral, while causing a "dramatic boom and bust" in Holland. At the same time, Italy was now trapped in slump with a "truly appalling export performance" and exorbitant unit labour costs.
The report said the risks of break-up had now reached a point where it had become necessary to "think more carefully about the costs and benefits of exiting".
HSBC said Germany might choose to leave in order to cut real interest rates, regain control of fiscal policy, and fight deflation by resorting to the sort of "unconventional" monetary methods in vogue in Tokyo and Washington - but denied by EU law to the European Central Bank.
Italy was deemed the prime candidate for exit, despite a belief that no "weak" economy can risk leaving EMU because of the risk of exploding debt-service costs on bonds.
HSBC said Rome might benefit from switching its existing national debt (now 107 percent of GDP) from euros to a weaker "new lira" - even if this amounted to a default. "The thing about sovereign debt is that the sovereign can do just about anything it likes on its domestic debt because it enacts the law that govern those securities," it said.
The report said real bond yields on fresh debt might jump from the current 1 percent to 4 percent, but this would have little impact on Italian growth as Italy's high-saving households would in turn receive a higher income on their bond holdings. With the right mix of policies, Italy might enjoy a "substantial" jump in growth.
HSBC said it was unclear what would happen to private contracts written in euros. "If Italy withdrew, the nature of the euro itself would be different, which could threaten to unravel even non-financial contracts," it said.
Nor is clear whether Italians could be forced to convert their stock of euro cash and bank accounts into new lira. HSBC warned that the "economic case for the re-establishment of the lira is far from overwhelming", arguing that the outcome would depend on whether or not Italy let rip on inflation.
Wednesday, July 13, 2005
HSBC has warned that Europe's common currency is working so badly that some countries may actually benefit from ditching the Euro, the British Telegraph reported on Tuesday.