Lest I be labeled a doom monger, I want to be clear on a few things. I do not believe that the eurozone will break up. Greece could — and probably will — be asked to leave sometime this summer, but most would agree that this would be addition by subtraction.
The other problem countries — most notably Spain — have shown the political resolve to do what is needed to stay in the eurozone. And the sovereign debt crisis is, first and foremost, a political problem with political solutions.
So again, the eurozone will survive.
But what if it doesn’t?
As investors, we have to ask ourselves uncomfortable questions. We also have to accept the limitations of our knowledge. Sometimes, no matter how rational or well-researched we are when forming an opinion, we are wrong. Good investors realize this and hedge their bets accordingly.
So what if I’m wrong? What if events spiral out of control and the euro as we know it ceases to be?
Today, I’m going to lay out a set of scenarios that investors could expect to see in the event that the eurozone breaks up and its member states resurrect the old currencies.
1. All former eurozone currencies would fall relative to a new German Deutschmark — even the currencies of relatively healthy economies such as the Netherlands and Finland — with the currencies of the PIIGS countries falling significantly harder and faster.
Currency collapse and hyperinflation almost certainly would follow, barring massive intervention by world central banks. And frankly, if relations between eurozone member states were to sink low enough to make dissolution a possibility, I couldn’t see coordinated intervention as a possibility. Europe would become a collection of little Argentinas, minus the juicy steaks and tango.
Currencies of non-euro European countries — such as the U.K., Norway and particularly Switzerland — instantly would soar to export-killing levels that would prompt their central banks to intervene. Major non-European currencies — particularly the U.S. dollar and Japanese yen — also would soar as potential havens from the storm. U.S. Treasuries and the dollar would soar to new all-time highs as investors had nowhere else to go.
2. Markets hate uncertainty, and in the post-dissolution chaos we likely would see stock market volatility on par with the 2008 meltdown — or worse.
We’ve all seen currency crises before; it was only a little more than a decade ago that we had the emerging-market currency and debt crisis that brought Long-Term Capital Management to an unceremonious death. When investors flee the capital markets, they do so in a hurry.
But remember that the European Union is collectively the largest economy in the world; if the likes of South Korea and Thailand could wreak havoc on world markets in 1998, imagine how much disruptive a euro dissolution would be. It would be the mother of all stock market crashes.
3. On a fundamental level, the story is more complicated. The economic dislocations likely would cause the worst recession since the Great Depression, which would devastate earnings and keep them depressed for years.
And good luck trying to value a European stock. The basic ratios that value investors use — price/earnings, price/sales, price/book value — all would be impossible to accurately calculate until the dust settled. This would be complicated further by the fact that most European blue chips have assets and sales across the European Union. I would pity the poor accountants tasked with assigning a fair market value — or even a historical value — to any of it.
I have no doubt in my mind that investors would find incredible bargains, once some sort of equilibrium was reached. But for months — and maybe years — investors would be better off staying away from Europe.