Debt Crisis: 3 Nightmare Scenarios for the Euro

ForexNewsNow – European politicians have had nightmares about it, and investors from all around the world fear it. The possible collapse of the euro as Europe’s single currency remains one of the worst scenarios possible for the euro zone in wake of the Debt Crisis.

Given the lack of federalism in the euro zone, countries that have had persistent trade deficits have dealt with it by simply going into debt; having no recourse to raise money from investors via so-called “Euro bonds”.

Moreover, according to a Natixis analysis, private investors are more and more reluctant to lend money to both the private and public sectors in countries that are already heavily in debt.

Given the lack of Euro bonds, at least in the near future, there are only three ways economically-weaker euro zone countries can avoid default:

• Europe accepts to lend money to these states through the European Central Bank (ECB) or the European Financial Stability Facility (EFSF), for example. However, is lending more money to countries already deeply in debt a viable solution or simply putting off the inevitable? It is interesting to note that, had Euro bonds existed, it would be the euro zone that would now be in debt and not the individual countries.
• These countries could drastically reduce their domestic demand until they completely cut their trade deficit as we have currently seen in Ireland. These measures imply a rise in unemployment and a lowering of purchasing power.
• These countries could abandon the Euro, which would no doubt result in very weak national currencies that would help reduce the national trade deficits. Nevertheless, this option would cause major problems for foreign creditors of those economies and involve myriad other expensive and complicating factors.

Conclusion

Obviously, the last two solutions would be outrageously costly for any country. The first solution only allows for a postponement of the problem.

In all cases, the euro would be seriously weakened on the forex markets against most major currencies. In other words, if countries from the euro area keep on having chronic deficits, the only reasonable solution will be to encourage a more federalist approach in Europe, especially with Euro bonds and wealth redistribution between euro zone countries.

But federalism seems out of the question, at least in the near future. The only hope may be in the 2013 elections in Germany, where political parties such as the SPD, Greens and even a fraction of the CDU, which are in favor of the “United States of Europe”, may have their voices heard.

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