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CASE STUDY: When will the euro collapse? It’s already dead

«You can have fun giving a spuriously precise answer — July 28th, 2014, is my favorite (look it up on Wikipedia if you are wondering why).

But the truth is no one really knows. The euro could stagger on from crisis summit to emergency bailout for another decade. Then again, it could be gone by the end of the month — if Greece is refused its third bailout, the country may be kicked out, and the entire currency could unravel over the course of a few chaotic days.

In reality, whether it is a few months or a decade away does not make as much difference as you might suppose.

Why not? Because in most of the ways that actually matter, the euro is already dead.

It no longer meets most of the criteria of a working form of money. There is an important point in that for investors. It is right now — while the currency no longer lives but still staggers on like a zombie — that the euro is wreaking most havoc on the countries of Europe. Once it is finally taken apart, markets in those nations can start to recover — potentially very rapidly.

Of course the euro still looks like a currency. There are notes and coins, and you can still go into a shop in Hamburg, or a café in Naples, and get stuff in return, even if there might be a certain amount of grumbling. There is a central bank, although it doesn’t appear to have much idea what its job is. And there are payment systems and foreign exchange markets that work as if the euro were a viable part of the global capital markets.

And yet if you think about it a little harder, the euro is not a currency in every sense of the word. A currency is only partly about notes and coins. It is also about being a universally accepted medium of exchange, a store of value over time, and a way of facilitating trade over long distances. That was why money evolved. And the euro doesn’t really meet those criteria any more.

Take interest rates, for example. In Germany, the yields on 10-year government bonds are less than 2%. In Spain they are close to 7%, and in Italy just under 6%. And in Greece? Don’t ask. Government bond yields matter — not just in themselves but because they set the benchmark for borrowing costs right across the economy. Some countries can’t use the euro for imports because of fears that drachmas or lire may suddenly replace euros.

There are already reports that oil traders don’t want to supply clients in Greece. Why not? Because in six months time when payment falls due they may not get paid in the currency the deal was struck in, but one worth much less. Much the same may soon be true of Spain as well.

And who can blame them? Oil is commodity that you can sell pretty easily right around the world. Why sell it to a country where there is a risk of not getting paid when there are so many alternative customers.

Meanwhile, money flees to safe havens.

London real estate agents report that the phones are ringing non-stop with wealthy euro-zone property buyers looking for somewhere to park their cash — and houses in the British capital look a safe bet. Swiss bankers are flush with cash exiting Italy and Germany. Everybody with any significant wealth wants at least part of it outside the euro zone because they are worried the currency might one day implode.

None of those are the kind of things that happen in functioning currency zones.

Take a comparison with the U.S. dollar, which really is a single currency for much of a whole continent.

Imagine, for example, that a company in Alabama had to pay three times as much to borrow as one in Maine, even though it was in the same business and had the same credit record but just happened to be unfortunate enough to be in the wrong part of the country. Or that a company in Boston couldn’t import automobiles in dollars because the supplier in Detroit wouldn’t accept their cash? Or that people in Texas were buying houses in California to protect themselves from the potential breakup of the currency union?

Very soon, the economy of the United States would cease to function. And we would start to wonder whether the dollar was still a currency in any meaningful sense.

But that is precisely the situation in the euro zone. The euro still has the notes and coins. But in almost every other sense, it is no longer really a currency.

This is more than just a semantic point. It is also important for investors to grasp.

When a currency stops working the damage done to the economy is immediate. Trade stops flowing. Investment gets postponed. Capital flees. Very quickly, unemployment starts to rise, and output declines.

That is precisely what is happening in the euro zone right now.

This part of the crisis — when the monetary system ceases to function in any meaningful way — may well be the worst point. But once countries such as Italy and Spain get their currencies back, there will be a very rapid improvement. Having any kind of functioning currency, even if it is one that has hugely depreciated in value, and doesn’t have much respect in the currency markets, is a lot better than having no currency at all.

The bounce-back in the economies of the countries that have suffered most from the euro will be very rapid. Most experts predict chaos — without understanding that chaos is what we have now. In fact, those economies will recover strongly as soon as they have a functioning currency again and so will their equity markers. The only real question is when they are cheap enough to start buying. »

Matthew Lynn, MarketWatch, WSJ

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