How the Euro Could Break Up—or Be Saved

By Ian WishartIan Wishart, Mira RojanasakulMira Rojanasakul and John FraherJohn Fraher
March 7, 2017

Talk about the breakup of the euro is fashionable again. With populists such as Marine Le Pen trying to storm the establishment and the popularity of the single currency in decline, executives and investors, including JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, say nothing can be ruled out. At the same time, the euro has already survived a number of scares since its inception in 1999, with the political and economic elites proving willing to do whatever it takes to support the currency.

We took a look at three scenarios that could lead to the euro splintering—and three that could see the currency coming through the populist wave in even stronger shape. And we poll expert opinion on the chances they could happen.

Three Ways the Euro Could Break Up

Scenario

No. 1

① After scandals hit her opponents, Marine Le Pen proves the opinion polls wrong by winning the second round of France's presidential election.

② Le Pen calls—and wins—a referendum on leaving the euro.

Euro / US Dollar Exchange Rate

③ A huge flight of capital begins not only in France but also in such other countries as Italy that have debated holding referenda on the euro. Capital controls are introduced.

④ Undeterred, Le Pen introduces the franc again and pegs it to what's left of the euro. That proves impossible, and the value of the new currency plunges.

France-Germany 10-Year Bond Spread

⑤ Chaos ensues in financial markets. No longer able to claim that the euro is irreversible, other euro-area governments follow suit, leaving only a core of northern European nations with a common currency.

What the experts say the chances are

"A victory of Mrs. Le Pen in the presidential election would probably lead France to leave the EMU. And without the political and economic heavyweight France, the rest of EMU is unlikely to survive."

— Joerg Kraemer, chief economist at Commerzbank

Data: Bloomberg Terminal

Scenario

No. 1

① After scandals hit her opponents, Marine Le Pen proves the opinion polls wrong by winning the second round of France's presidential election.

② Le Pen calls—and wins—a referendum on leaving the euro.

Euro / US Dollar Exchange Rate

③ A huge flight of capital begins not only in France but also in such other countries as Italy that have debated holding referenda on the euro. Capital controls are introduced.

④ Undeterred, Le Pen introduces the franc again and pegs it to what's left of the euro. That proves impossible, and the value of the new currency plunges.

France-Germany 10 Year Bond Spread

⑤ Chaos ensues in financial markets. No longer able to claim that the euro is irreversible, other euro-area governments follow suit, leaving only a core of northern European nations with a common currency.

What the experts say the chances are

"A victory of Mrs. Le Pen in the presidential election would probably lead France to leave the EMU. And without the political and economic heavyweight France, the rest of EMU is unlikely to survive."

— Joerg Kraemer, chief economist at Commerzbank

Data: Bloomberg Terminal

Scenario No. 1

① After scandals hit her opponents, Marine Le Pen proves the opinion polls wrong by winning the second round of France's presidential election.

② Le Pen calls—and wins—a referendum on leaving the euro.

③ A huge flight of capital begins not only in France but also in such other countries as Italy that have debated holding referenda on the euro. Capital controls are introduced.

Euro / US Dollar Exchange Rate

④ Undeterred, Le Pen introduces the franc again and pegs it to what's left of the euro. That proves impossible, and the value of the new currency plunges.

⑤ Chaos ensues in financial markets. No longer able to claim that the euro is irreversible, other euro-area governments follow suit, leaving only a core of northern European nations with a common currency.

France-Germany 10-Year Bond Spread

What the experts say the chances are

"A victory of Mrs. Le Pen in the presidential election would probably lead France to leave the EMU. And without the political and economic heavyweight France, the rest of EMU is unlikely to survive."

— Joerg Kraemer, chief economist

at Commerzbank

Data: Bloomberg Terminal

Scenario

No. 2

① Already on the brink of collapse, Italy’s banking system suffers a mortal blow when EU regulators shoot down a government lifeline of €20 billion, claiming it to be state aid.

Italy Bank Bad Debts (of Domestic General Government and Other Sectors)

② Italy-Germany bond spreads hit record highs, and there’s a run on banks, prompting the new government to impose capital controls before quickly resigning.

Italian General Election, 2013

% of Vote to Five Star Movement

③ After years of subpar growth, unemployment and intermittent financial crises, Italy turns euro- skeptic. Five Star wins the next election and forms a coalition with the Northern League on a joint platform to bring back the lira.

0–10%

10–15%

15–20%

20–30%

30–40%

40–50%

Italy 5-year CDS

④ They nationalize the country's banks and win a referendum on euro membership, ending Italy's 18-year experiment with the single currency.

What the experts say the chances are

—Jim Mellon, chairman of the Burnbrae Group

"It wouldn’t take much for one of Europe’s biggest economies, where the euro is already unpopular, to be tipped into crisis. It’s Italy, not Greece or France, that’s most likely to bring down the single currency."

— BI Economics

 

Data: Bloomberg Terminal, Bank of Italy, Italy’s Department of Internal and Territorial Affairs

Scenario

No. 2

Italy Bank Bad Debts (of Domestic General Government and Other Sectors)

① Already on the brink of collapse, Italy’s banking system suffers a mortal blow when EU regulators shoot down a government lifeline of €20 billion, claiming it to be state aid.

② Italy-Germany bond spreads hit record highs, and there’s a run on banks, prompting the new government to impose capital controls before quickly resigning.

③ After years of subpar growth, unemployment and intermittent financial crises, Italy turns euro- skeptic.

Five Star wins the next election and forms a coalition with the Northern League on a joint platform to bring back

the lira.

Italy 5-year CDS

Italian General Election, 2013

% of Vote to Five Star Movement

④ They nationalize the country's banks and win a referendum on euro membership, ending Italy's 18-year experiment with the single currency.

0–10%

10–15%

15–20%

20–30%

30–40%

40–50%

What the experts say the chances are

—Jim Mellon, chairman of the Burnbrae Group

"It wouldn’t take much for one of Europe’s biggest economies, where the euro is already unpopular, to be tipped into crisis. It’s Italy, not Greece or France, that’s most likely to bring down the single currency."

— BI Economics

 

Data: Bloomberg Terminal, Bank of Italy, Italy’s Department of Internal and Territorial Affairs

Scenario No. 2

① Already on the brink of collapse, Italy’s banking system suffers a mortal blow when EU regulators shoot down a government lifeline of €20 billion, claiming it to be state aid.

Italy Bank Bad Debts (of Domestic General Government and Other Sectors)

② Italy-Germany bond spreads hit record highs, and there’s a run on banks, prompting the new government to impose capital controls before quickly resigning.

Italian General Election, 2013

% of Vote to Five Star Movement

0–10%

10–15%

15–20%

20–30%

30–40%

40–50%

③ After years of subpar growth, unemployment and intermittent financial crises, Italy turns euro- skeptic. Five Star wins the next election and forms a coalition with the Northern League on a

joint platform to bring back

the lira.

④ They nationalize the country's banks and win a referendum on euro membership, ending Italy's 18-year experiment with the single currency.

Italy 5-year CDS

What the experts say the chances are

—Jim Mellon, chairman of the Burnbrae Group

"It wouldn’t take much for one of Europe’s biggest economies, where the euro is already unpopular, to be tipped into crisis. It’s Italy, not Greece or France, that’s most likely to bring down the single currency."

— BI Economics

 

Data: Bloomberg Terminal, Bank of Italy, Italy’s Department of Internal and Territorial Affairs

Scenario

No. 3

① With creditors asking for more pension cuts, Prime Minister Alexis Tsipras’s government calls a snap election, saying none of this was part of the bailout deal agreed to in 2015.

② Tsipras’s move helps him claw back his estranged voters and win the election on an explicit promise to abandon austerity.

③ With the populist backlash forcing other euro-area governments to take a harder line on Greece, Tsipiras wins little sympathy abroad.

④ This time Greece doesn't blink. Athens defaults on its debt held at the European Central Bank, prompting the ECB to pull the plug on its banks.

Greece Bond Yield Curve

Greek Poverty Rate

⑤ Deposits are redenominated into promissory notes, a form of IOU, as companies and the government are forced into bartering goods and services while a new currency is printed.

⑥ This paves the way for Greece’s departure from the euro area.

What the experts say the chances are

"This implosion of the euro zone is getting closer. The most vulnerable are Italy, France, Portugal and Greece. I expect one to be gone in 18 months’ time. There will be no warning or negotiations."

—Jim Mellon, chairman of the Burnbrae Group

 

Data: Bloomberg Terminal, National Statistical Service of Greece

Scenario

No. 3

① With creditors asking for more pension cuts, Prime Minister Alexis Tsipras’s government calls a snap election, saying none of this was part of the bailout deal agreed to

in 2015.

② Tsipras’s move helps him claw back his estranged voters and win the election on an explicit promise to abandon austerity.

③ With the populist backlash forcing other euro-area governments to take a harder line on Greece, Tsipiras wins little sympathy abroad.

Greece Bond Yield Curve

④ This time Greece doesn't blink. Athens defaults on its debt held at the European Central Bank, prompting the ECB to pull the plug on its banks.

Greek Poverty Rate

⑤ Deposits are redenominated into promissory notes, a form of IOU, as companies and the government are forced into bartering goods and services while a new currency is printed.

⑥ This paves the way for Greece’s departure from the euro area.

What the experts say the chances are

"This implosion of the euro zone is getting closer. The most vulnerable are Italy, France , Portugal and Greece. I expect one to be gone in 18 months’ time. There will be no warning or negotiations."

—Jim Mellon, chairman of the Burnbrae Group

 

Data: Bloomberg Terminal, National Statistical Service of Greece

Scenario No. 3

① With creditors asking for more pension cuts, Prime Minister Alexis Tsipras’s government calls a snap election, saying none of this was part of the bailout deal agreed to in 2015.

② Tsipras’s move helps him claw back his estranged voters and win the election on an explicit promise to abandon austerity.

③ With the populist backlash forcing other euro-area governments to take a harder line on Greece, Tsipiras wins little sympathy abroad.

④ This time Greece doesn't blink. Athens defaults on its debt held at the European Central Bank, prompting the ECB to pull the plug on its banks.

Greece Bond Yield Curve

⑤ Deposits are redenominated into promissory notes, a form of IOU, as companies and the government are forced into bartering goods and services while a new currency is printed.

Greek Poverty Rate

⑥This paves the way for Greece’s departure from the euro area.

What the experts say the chances are

"This implosion of the euro zone is getting closer. The most vulnerable are Italy, France , Portugal and Greece. I expect one to be gone in 18 months’ time. There will be no warning or negotiations."

—Jim Mellon, chairman of the Burnbrae Group

 

Data: Bloomberg Terminal, National Statistical Service of Greece

Three Ways the Euro Could Be Saved

Scenario

No. 1

① Europe's minds are focused by twin crises from across the Atlantic and along Europe’s eastern borders.

② U.S. President Donald Trump starts a punitive trade war with Germany, while Russian President Vladimir Putin starts testing NATO's borders in earnest.

③ Faced by the biggest existential threat to European security since World War II, Germany decides to throw in its lot fully with the rest of Europe.

Euro Area Annual GDP Growth

④ German Chancellor Angela Merkel agrees to a fiscal union with the rest of the euro zone in return for German-mandated budget discipline.

Euro-zone Budget Balance (% GDP)

⑤ The Grand Bargain—signed under the Arc de Triomphe— ends years of ambiguity about the financial bonds that hold the currency bloc together. The euro soars.

What the experts say the chances are

— Holger Schmieding, Berenberg

"Things are harder now, and it would be even more difficult for northern European countries to accept a debt mutualization with the weaker countries."

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal, Eurostat

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario No. 1

① Europe's minds are focused by twin crises from across the Atlantic and along Europe’s eastern borders.

② U.S. President Donald Trump starts a punitive trade war with Germany, while Russian President Vladimir Putin starts testing NATO's borders in earnest.

③ Faced by the biggest existential threat to European security since World War II, Germany decides to throw in its lot fully with the rest of Europe.

Euro Area Annual GDP Growth

④ German Chancellor Angela Merkel agrees to a fiscal union with the rest of the euro zone in return for German-mandated budget discipline.

Euro-zone Budget Balance (% GDP)

⑤ The Grand Bargain—signed under the Arc de Triomphe— ends years of ambiguity about the financial bonds that hold the currency bloc together. The euro soars.

What the experts say the chances are

— Holger Schmieding, Berenberg

"Things are harder now, and it would be even more difficult for northern European countries to accept a debt mutualization with the weaker countries."

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal, Eurostat

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario No. 1

① Europe's minds are focused by twin crises from across the Atlantic and along Europe’s eastern borders.

② U.S. President Donald Trump starts a punitive trade war with Germany, while Russian President Vladimir Putin starts testing NATO's borders in earnest.

③ Faced by the biggest existential threat to European security since World War II, Germany decides to throw in its lot fully with the rest of Europe.

Euro-zone Budget Balance (% GDP)

④ German Chancellor Angela Merkel agrees to a fiscal union with the rest of the euro zone in return for German-mandated budget discipline.

Euro Area Annual GDP Growth

⑤ The Grand Bargain—signed under the Arc de Triomphe—ends years of ambiguity about the financial bonds that hold the currency bloc together. The euro soars.

What the experts say the chances are

— Holger Schmieding, Berenberg

"Things are harder now, and it would be even more difficult for northern European countries to accept a debt mutualization with the weaker countries."

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal, Eurostat

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario

No. 2

① As criticism of Merkel's refugee policy intensifies, Germans conclude that it's finally time for change. She fails to win a fourth term as chancellor and is replaced by Martin Schulz, the Social Democrat candidate.

Support for the euro in

Germany, 2016

② Schulz proves to be much more willing to tolerate looser fiscal policy, and European creditors relax Greece's austerity targets. The country leaves its bailout program in 2018 and returns to the bond markets.

German Budget Balance (% GDP)

③ Schulz resurrects his support for eurobonds—debt issued jointly by euro-area nations—and, relieved to get through 2017 with the EU still intact, his fellow leaders give them the go-ahead.

U.S. Trade Balance With Germany

④ Schulz slowly breaks with Merkel's economic policy and starts a period of modest fiscal expansion at home, boosting domestic demand. Germany's trade surplus with the U.S. begins to shrink, reducing tension with the Trump administration.

⑤ A modest fiscal union comes into being, with German taxpayers agreeing to underpin the spending of southern European governments in certain circumstances.

⑥ Tsipras welcomes Schulz to Athens. Cheering crowds greet the German chancellor as newspapers herald him for saving Greece and the euro.

What the experts say the chances are

— Holger Schmieding, Berenberg

The tone might be different [from Merkel’s] but I don't think that of all sudden they will start implementing euro bonds and a European finance ministry. This is unlikely.''

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal, U.S. Census Bureau, Bertelsmann Stiftung poll taken between March–August 2016

Scenario

No. 2

① As criticism of Merkel's refugee policy intensifies, Germans conclude that it's finally time for change. She fails to win a fourth term as chancellor and is replaced by Martin Schulz, the Social Democrat candidate.

② Schulz proves to be much more willing to tolerate looser fiscal policy and European creditors relax Greece's austerity targets. The country leaves its bailout program in 2018 and returns to bond markets.

Support for the euro in

Germany, 2016

German Budget Balance (% GDP)

③ Schulz resurrects his support for eurobonds— debt issued jointly by euro-area nations— and, relieved to get through 2017 with the EU still intact, his fellow leaders give them the go-ahead.

U.S. Trade Balance With Germany

④ Schulz slowly breaks with Merkel's economic policy and starts a period of modest fiscal expansion at home, boosting domestic demand. Germany's trade surplus with the U.S. begins to shrink, reducing tension with the Trump administration.

⑤ A modest fiscal union comes into being, with German taxpayers agreeing to underpin the spending of southern European governments in certain circumstances.

⑥ Tsipras welcomes Schulz to Athens. Cheering crowds greet the German chancellor as newspapers herald him for saving Greece and the euro.

What the experts say the chances are

— Holger Schmieding, Berenberg

The tone might be different [from Merkel] but I don't think that of all sudden they will start implementing euro-bonds and European finance ministry. This is unlikely.''

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal,

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario No. 2

① As criticism of Merkel's refugee policy intensifies, Germans conclude that it's finally time for change. She fails to win a fourth term as chancellor and is replaced by Martin Schulz, the Social Democrat candidate.

Support for the euro in

Germany, 2016

② Schulz proves to be much more willing to tolerate looser fiscal policy and European creditors relax Greece's austerity targets. The country leaves its bailout program in 2018 and returns to bond markets.

German Budget Balance (% GDP)

③ Schulz resurrects his support for eurobonds—debt issued jointly by euro-area nations—and, relieved to get through 2017 with the EU still intact, his fellow leaders give them the go-ahead.

U.S. Trade Balance With Germany

④ Schulz slowly breaks with Merkel's economic policy and starts a period of modest fiscal expansion at home, boosting domestic demand. Germany's trade surplus with the U.S. begins to shrink, reducing tension with the Trump administration.

⑤ A modest fiscal union comes into being, with German taxpayers agreeing to underpin the spending of southern European governments in certain circumstances.

⑥ Tsipras welcomes Schulz to Athens. Cheering crowds greet the German chancellor as newspapers herald him for saving Greece and the euro.

What the experts say the chances are

— Holger Schmieding, Berenberg

The tone might be different [from Merkel] but I don't think that of all sudden they will start implementing euro-bonds and European finance ministry. This is unlikely.''

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal,

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario

No. 3

① Le Pen loses, Greece doesn’t default, Italy’s banks stagger on and Merkel wins, prolonging her status as the euro area’s de facto leader.

Euro STOXX 50 Volatility Index

② Barely noticed amid excited coverage of traumatic Brexit negotiations and Trump’s first months in office, the EU celebrates its 60th anniversary by producing a dull roadmap on the future of the euro.

 

③ Free from the pressure of Europe’s turbulent election year, Merkel and her fellow leaders discuss creating a finance minister for the euro area—but in a few years time.

Bloomberg Europe 500 Banks and Financial Services Index

④ Greece’s reluctance to implement austerity to unlock bailout funds creates a minor crisis every year, but there’s an 11th-hour deal every time, and the Greek economy gradually improves.

⑤ Sporadic concerns about the fragility of banks encourages the

euro area finally to move toward completing the banking union and

introducing a common deposit guarantee system.

 

Oslo

Stockholm

Tallinn

Edinburgh

Riga

Copenhagen

Amsterdam

Warsaw

London

Frankfurt

Paris

Vienna

Munich

Support for the EU

Milan

Good thing

Bad thing

Other

81%

Ireland

Rome

74%

Luxembourg

Madrid

67%

Austria

Lisbon

66%

Finland

64%

Germany

64%

Malta

⑥ It’s 2020, 10 years after Greece’s first bailout and the euro area is still intact. In fact, more countries line up to join. There’s still no fiscal union—but that can wait.

 

64%

Estonia

63%

Slovakia

61%

Netherlands

60%

Slovenia

57%

Spain

56%

Euro area

56%

Latvia

54%

Belgium

54%

Greece

53%

France

52%

Portugal

42%

Lithuania

41%

Italy

40%

Cyprus

What the experts say the chances are

— Holger Schmieding, Berenberg

"This is the most likely scenario."

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal,

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario

No. 3

① Le Pen loses, Greece doesn’t default, Italy’s banks stagger on and Merkel wins, prolonging her status as the euro area’s de facto leader.

Euro STOXX 50 Volatility Index

② Barely noticed amid excited coverage of traumatic Brexit negotiations and Trump’s first months in office, the EU celebrates its 60th anniversary by producing a dull roadmap on the future of the euro.

 

Bloomberg Europe 500 Banks and Financial Services Index

③ Free from the pressure of Europe’s turbulent election year, Merkel and her fellow leaders discuss creating a finance minister for the euro area—but in a few years time.

④ Greece’s reluctance to implement austerity to unlock bailout funds creates a minor crisis every year, but there’s an 11th-hour deal every time, and the Greek economy gradually improves.

⑤ Sporadic concerns about the fragility of banks encourages the euro area finally to move toward completing the banking union and introducing a common deposit guarantee system.

 

Oslo

Stockholm

Tallinn

Edinburgh

Riga

Copenhagen

Amsterdam

Warsaw

London

Frankfurt

Paris

Vienna

Munich

Milan

Support for the EU

Rome

Good thing

Bad thing

Other

Madrid

Ireland

Lisbon

Luxembourg

Austria

Finland

Germany

⑥ It’s 2020, 10 years after Greece’s first bailout and the euro area is still intact. In fact, more countries line up to join. There’s still no fiscal union—but that can wait.

 

Malta

Estonia

Slovakia

Netherlands

Slovenia

Spain

Euro area

Latvia

Belgium

Greece

France

Portugal

Lithuania

Italy

Cyprus

What the experts say the chances are

— Holger Schmieding, Berenberg

"This is the most likely scenario."

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal,

Bertelsmann Stiftung poll taken between

March–August 2016

Scenario No. 3

① Le Pen loses, Greece doesn’t default, Italy’s banks stagger on and Merkel wins, prolonging her status as the euro area’s de facto leader.

Euro STOXX 50 Volatility Index

② Barely noticed amid excited coverage of traumatic Brexit negotiations and Trump’s first months in office, the EU celebrates its 60th anniversary by producing a dull roadmap on the future of the euro.

 

Bloomberg Europe 500 Banks and Financial Services Index

③ Free from the pressure of Europe’s turbulent election year, Merkel and her fellow leaders discuss creating a finance minister for the euro area—but in a few years time.

④ Greece’s reluctance to implement austerity to unlock bailout funds creates a minor crisis every year, but there’s an 11th-hour deal every time, and the Greek economy gradually improves.

Oslo

Stockholm

Tallinn

Edinburgh

Riga

Copenhagen

Amsterdam

Warsaw

London

Frankfurt

Paris

Vienna

Munich

Milan

Rome

Madrid

Lisbon

⑤ Sporadic concerns about the fragility of banks encourages the euro area finally to move toward completing the banking union and introducing a common deposit guarantee system.

 

Support for the EU

Good thing

Bad thing

Other

Ireland

Luxembourg

Austria

Finland

Germany

Malta

Estonia

Slovakia

Netherlands

Slovenia

Spain

Euro area

Latvia

Belgium

Greece

France

Portugal

Lithuania

Italy

Cyprus

⑥ It’s 2020, 10 years after Greece’s first bailout and the euro area is still intact. In fact, more countries line up to join. There’s still no fiscal union—but that can wait.

 

What the experts say the chances are

— Holger Schmieding, Berenberg

"This is the most likely scenario."

— Nick Kounis, ABN Amro

 

Data: Bloomberg Terminal,

Bertelsmann Stiftung poll taken between

March–August 2016