As the cost of a euro-zone break-up continues to rise exponentially, JPMorgan has concluded that Germany’s best option is to leave the euro. With German taxpayers outraged by the dangerous rise in credit risk resulting from a plethora of backdoor bail-out schemes, carrying on regardless now looks politically suicidal for Chancellor Merkel in the wake of the Christian Democrats’ worst state election result in North Rhine-Westphalia since the Second World War.
The writing on the wall, as I wrote in Germany’s Approaching Götterdämmerung, is the Bundesbank’s TARGET2 balances (see chart 1), which reached a new high of €644 billion in April. Germany is now on the hook for much of the €2.1 trillion in rescue measures that will saddle Germans with ruinous losses one day. That is why Germany may have been planning an exit for some time. Why else did it offer Greece and others bailouts on such onerous terms that the likelihood of them being accepted was virtually zero?
Taking a look at the consequences of a Greek exit for the rest of the euro-zone JPMorgan has totted up some numbers. The immediate losses add up to €400 billion: €240 billion of Greek debt in in the hands of the EU and the IMF, the €130 billion of the eurosystem’s exposure to Greece via TARGET2, and a potential loss of around €25 billion for the banks (most of them French).
But the indirect consequences are huge, given that the markets see Greece as a precedent for the other peripheral euro-zone members. The €800bn of Italian and Spanish government bonds still held by non-domestic investors are likely at risk, as are the €500bn of Italian and Spanish bank and corporate bonds and the €300bn of quoted Italian and Spanish shares held by non-residents.
It gets worse: “The numbers balloon if one starts looking beyond portfolio/quoted assets. Of course, the €1.4 trillion of Italian and €1.6 trillion of Spanish bank domestic deposits is the elephant in the room which a Greek exit and the introduction of capital controls by Greece has the potential to destabilize (see chart 2).”
The Western European banking system is already broken. European leaders, by brushing its bad debts under the carpet – remember the bank ‘stress tests’? – have starved firms and households of working capital by paralysing the market with the fear of counter-party risk. Another, much more severe banking crisis is upon us, the consequences of which will be as profound for emerging markets as it is for Europe.