The modern industrial economy rests on three pillars: finance, government and industry. A sudden break-up of the euro zone would damage all three.
The 2008 failure of Lehman Brothers sets a stupidly grim precedent. Fear spread like wildfire across the previously pampered financial sector, producers panicked and the fiscal and monetary authorities dawdled. But the lessons should have been learned. In theory, there is time to prepare for an uneventful return to the pre-euro order of one country-one currency.
In practice, though, no one is close to ready. On the contrary, the financial pillar is already tottering. Depositors and institutional investors are undermining its foundations by running to ever shrinking islands of safety. If the euro fell, the financial equivalent of a multi-car pile-up would be likely: banks deprived of liquidity pull loans, induce recession, run up losses and go out of business. Asset markets become dysfunctional and central banks cannot keep up.
The government has a potent weapon to counter financial shortages: the electronic equivalent of the printing press. An empowered Greek central bank could do it just as well as the European Central Bank. But too much of such monetary creation out of nothing debases currencies and destroys trust. Fiscal deficits and monetary support are already high, so another significant increase in official activism would test the limits of the monetary imperium. The second economic pillar looks brittle.
If any significant governments lose their credibility – France, Italy, the United States and UK are all candidates – global financial disarray is all but certain. The result would be a hit to the third pillar, industry. World trade fell 11 percent in 2009 and global GDP declined by 0.7 percent. With governments weaker now than then, those declines could be doubled or tripled this time around. The chaos might tempt some government to use one of their non-economic powers: to engage in war.
As investor fear grows, severe industrial damage becomes more likely. But despair is still premature. In both finance and government, almost everyone sees that a messy break-up of the euro leads to disaster. There is still enough time to salvage the situation.