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Breakup of the eurozone would prompt global recession

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While the brunt of the catastrophe would be felt primarily by the weak (formerly peripheral) economies, the stronger (formerly core) countries would also take a substantial hit.

Let us look at each in turn.

In returning to their national currencies, the weaker eurozone economies would stand to regain control of a broader set of policy instruments. As such, they would have greater means to pursue the competitive gains that are essential to restoring their growth dynamics and generating jobs.

But to do so effectively would require deft management of a major currency devaluation. They would thus have to counter significant inflationary pressures and the higher costs of imports, disrupted banking and monetary transmission channels, and soaring risk premiums. And with the whole of Europe disrupted, they would find that the price advantages gained via devaluation risked being eroded by a collapse in regional demand.

Moreover, given currency mismatches, a wide-scale return to national currencies could well involve a string of payment defaults, along with some coercive restructurings and a forced conversion of euro assets into new depreciated national currencies

The issues of regional demand and defaults are also of significance to the stronger economies. Notwithstanding the gains they have made in trade diversification, including a greater reorientation towards emerging countries, a significant amount of their exports are still sold in Europe. This market collapse would come on top of the losses due to rapidly eroding financial claims on the weaker economies defaulting on their euro debts, both directly and via the likely need to recapitalize regional institutions.

Debt restructuring, and even outright defaults, would impair the balance sheets of creditor institutions, increasing their own debt (because they will have the same assets but greater liabilities) and costs of capital. And the AAA rating of Germany and other core eurozone members would also be put at risk.

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