What Happens if the Euro Breaks Up?

If nothing is accomplished this week at the summit on eurozone problems, then we will see more firms get ready for the abolishment of the euro. But what happens if the euro breaks up?As 2011 rolls to a close, we have seen some violent moves in stocks, commodities, interest rates and currencies. It seems as if the bottom is in; the future is bright, as Europe is about to end all of their problems this Friday. However, I wouldn’t move so fast in calling an end to the volatility in the markets.

We just came off a very strong week in the markets, after learning about the liquidity injection by the Federal Reserve and world central bankers. Yet again, the headline looks great, but when one peels back the onion’s layers, it starts to stink.

If we look at short-term Treasury bill yields, we see that they are still negative. What this means is that investors are literally paying their own money, so they can park it in short-term Treasuries, because they’re too scared to invest it in anything else! They’re essentially willing to lose a little cash every day rather than stick their necks out into the markets.

Yes, the longer-dated bonds have gone up in yield as investors have sold those, but short-term paper is essentially cash for immediate investment. So much for the confidence boost by the Federal Reserve if large institutional investors would rather keep their money under the mattress.


I don’t blame investors for being scared. Even as eurozone leaders are getting ready for the big summit to discuss solving their issues, there is a report that Standard & Poor’s is about to warn Germany and the top eurozone nations that they risk having their sovereign debt downgraded. No one has expected Germany to be downgraded. This would be another shock to an already fragile financial system, especially in the eurozone. All of this is before we find out if anything is even resolved! Another sign that there is a general lack of confidence in the eurozone leaders.

If nothing is accomplished this week, then we will see more firms get ready for the abolishment of the euro. There are some firms that are already calculating for this possibility. A report out by financial firm Nomura Securities calculated what the individual currencies would be worth in relation to the euro if they broke apart. Only Germany would have a slight premium, but some countries like Greece and Portugal would have devaluations in excess of 50%, while most of the remaining eurozone nations would be devalued in the range of 25%-35%.

With this kind of outlook, what has worked before will continue to work…and that is being net long of gold and avoiding the euro. The price of gold has been extremely strong before any real talk of a break-up has even occurred on the part of eurozone leaders. If the eurozone were to break up the euro currency, there would be a mad dash into gold and precious metals. If you were a citizen in the eurozone and you knew that your currency would be worth 40% less tomorrow, wouldn’t you try to protect yourself from that kind of value destruction? Of course you would; but most people are not hedged, as they keep hoping that things will somehow miraculously be solved.

After almost a decade of false promises in the eurozone and hopes dashed, there is little faith in leadership. A complete abolishment of the eurozone currency would result in a rush into gold and no one can predict what the price would be. We do know that, in this situation, the price would certainly be much, much higher.