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Is a Eurozone breakup now inevitable -- and imminent?

November 27, 2011 |  5:41 pm

Eurofire
Europe enters the new week at a crucial point in its 2-year-old financial crisis, with a growing number of analysts warning that the 17-nation Eurozone is in serious danger of unraveling.

What that would mean, exactly, is in large part unknown, because there is no precedent for it. It’s easy to say that countries such as Greece would go back to using their pre-1999 currencies, but the reality would be devastating on many levels.

For example, Greece’s crushing debt is denominated in euros. If the country went back to using the drachma, the new currency presumably would be worth a fraction of a euro. So Greece’s debt burden would become even bigger. The banks and other investors that own Greek bonds could face a massive wipeout.

Oddly enough, though the euro currency has weakened in recent days, it hasn’t fallen to the depths reached in the global financial meltdown of 2008. The euro dived to $1.245 in November of that year. It ended last week at $1.324, down from a recent high of $1.419 on Oct. 27.

The Economist magazine wondered in a weekend story why the currency market isn’t more worried, and  why the European Central Bank and Germany continue to oppose emergency moves to halt the crisis:

A euro breakup would cause a global bust worse even than the one in 2008-09. The world’s most financially integrated region would be ripped apart by defaults, bank failures and the imposition of capital controls. The euro zone could shatter into different pieces, or a large block in the north and a fragmented south.

Amid the recriminations and broken treaties after the failure of the European Union’s biggest economic project, wild currency swings between those in the core and those in the periphery would almost certainly bring the single market to a shuddering halt. The survival of the EU itself would be in doubt.

The immediate problem is that investors continue to shun European government bonds, driving interest rates up and thereby digging a deeper hole for countries that need to refinance debt.

Markets will be tested early this week as Italy, Belgium and Spain try to issue new bonds. There were reports Sunday of possible new International Monetary Fund aid for Italy.

Last week, the market yield on two-year Italian bonds ended the week at 7.66%, a new euro-era high and up from 6.12% a week earlier and 3.4% in mid-August.

Carl Weinberg, chief economist at High Frequency Economics, warned in a report Sunday that some European banks are nearing the breaking point as their bond holdings plunge in value, erasing capital from their balance sheets.

“We believe the endgame is now in sight, with bank failures likely at year-end, or perhaps sooner,” Weinberg said. “We worry about a credit crunch strangling the economy of the Eurozone: Banks with capital deficiencies do not write loans.”

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U.S. banks face rising risk from Eurozone crisis

-- Tom Petruno

Photo: Flames from a fire set alight in a container by activists with the global Occupy movement are seen in front of the European Central Bank and a sculpture of the euro symbol in Frankfurt, Germany. Credit: Michael Probst / Associated Press

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