WINDSOR, England -- Breaking up may be hard to do, but not everyone believes a collapse of the euro is impossible.
While many European observers think withdrawal from the European economic and monetary union is inconceivable, Neil Record, chairman of Record Treasury Management, Windsor, believes central bankers should think the unthinkable.
"The issue to me is the Titanic," Mr. Record said. The manufacturers of the ill-fated ship thought it was unsinkable, and thus failed to provide enough lifeboats.
"The key issue is, there's a non-zero probability of EMU not surviving in its current form forever," Mr. Record said.
The problem is getting the euro's architects to discuss the possibility of the new currency's collapse, he said.
The Euroskeptic admits that his disaster scenario is irrelevant if a single currency leads to political union among European Union countries.
But the prospect of European states ceding sovereignty to a central government is fraught with greater difficulties, he said, flying in the face of hundreds of years of cultural and political differences.
Bankers should face up to the possible ramifications of a country exiting the euro or of another major crisis occurring during the next few years, he said.
An April survey by Banque Paribas, London, found that 26% of 80 global investors believe there's a chance of a breakup, with 13% of those surveyed believing a breakup will occur before 2002.
Nick Horsfall, a senior investment consultant with Watson Wyatt Worldwide, Reigate, England, said, "It's fairly unlikely that (the euro) will fall apart but it should be factored in."
Mr. Record estimates there's a 10% to 20% risk of breakup during the first three years of the euro.
"It's a certainty (the euro) will not survive in its current form forever," he said.
RISK OF EXIT
In a newsletter article, Mr. Record posed a couple of possible scenarios that could lead to the exit of a major country from the euro.
For example, if France's unemployment rate were to soar to 17%, the right-wing National Front could run on a policy of quitting EMU, devaluing the franc, imposing capital and exchange controls, and imposing taxes on non-French companies.
The National Front wouldn't need to win a majority vote, just enough to ensure that any other party needed its participation to form a government. The National Front could tie its support to leaving EMU, he suggested.
Alternatively, Italy might transfer the burden of funding state pensions to the private sector, he speculated. That shift would rid the Italian government of a debt equal to 16% of gross domestic product and would reduce government expenditures, bringing the government in line with the stability pact.
But the German government might question the rapid growth in credit in Italy. Germany and other key EMU states could propose tighter monetary controls for a "super-EMU" group of countries, creating a "SuperEuro," he wrote. France, choosing not to join the SuperEuro, could return to the franc if the old euro were to trade at a substantial discount to the new currency.
"If we're prudent, we must ask the question of what happens if a country exited (the euro) or (the euro) split in two," Mr. Record said.
From the onset of the euro, Mr. Record predicts that a break-up premium will apply to countries deemed at greatest risk by the market. Because monetary policy will be unified, this premium will be reflected in interest rates, and will be imposed on top of credit-risk premiums.
For example, debt issued by a AAA-rated Italian company could carry a higher yield than that of a AAA-rated German company.
The markets themselves would set the premiums; domestic investors also could perceive greater risk in domestic securities. However, it will necessarily not be clear where a euro debt is domiciled, Mr. Record observed.
While Italian government debt owned by Italian investors clearly will be considered domestic, it's less clear about multinational euro corporate debt held by Italian banks. And a euro banknote will be a liability of the European Central Bank.
The biggest risk of an exit could be collapse of Europe's banking system, he warned.
While EMU country banks are required to treat all euro-denominated debt the same, investors and savers would take a different view if they thought they were at risk.
Thus the prospect of France's exit from the euro would cause investors to worry they faced devaluation of existing assets. The likely response would be to shift investments and deposits out of French banks and French-domiciled euro debt and into foreign banks and bonds issued, for example, in Germany.
The breakup risk premiums for French securities would soar. Money flows would drive down the price of French bonds. Yields on French bonds would increase, while those on German bonds would decline.
What's more, this pressure would cause a run on French banks. The only way to avoid collapse of the banks would be an immediate exit from the euro.
However, the new franc would trade at a discount to the market, potentially rendering the entire French banking sector insolvent.
The only way out for the French would be global redenomination, but that could trigger a global banking crisis, Mr. Record wrote. If the French government refused to pick up the cost of a bank rescue, French banks could collapse anyway, prompting a global banking failure, he added.
The problem with the euro is a design flaw, he said. It's not the Maastricht Treaty with its EMU entrance criteria that is flawed, but the notion that the euro is irrevocable, he said.