Eurozone Exits 'May Spark Global Depression'

Ed Conway, economics editor

The Organisation for Economic Cooperation and Development has warned that an exit out of the eurozone by some countries could cause "wealth destruction" and a global "deep depression".

OECD chief economist Pier Carlo Padoan warned rather cryptically that the international organisation’s latest economic forecasts did not take into account the possibility of a "large negative event".

If you’re wondering what he might mean by that, here are some selected excerpts from the OECD’s economic outlook on the possibility of a euro break-up.

Warning: these predictions are not for the squeamish.

"In a worst-case situation, albeit one with only a small probability of occurring, the downside scenario above could be strongly accelerated and amplified if it was accompanied by one or several countries leaving the euro area and re-establishing their own national currencies - or even just by expectations thereof," the outlook stated.

"For instance, this could be prompted by the need to restore external competitiveness after a large erosion since entry into the currency union.

"Although this would most likely prove to be extremely costly for the country in question in the short run, and possibly even in the long run, euro area exit might nevertheless be seen as a politically less unappealing option for countries under market pressure."

As a consequence, investors would start demanding compensation for possible exchange rate risk in the form of higher interest rates on public and private debt in other vulnerable countries that remain members of the euro area.

"There would also be strong incentives for households and businesses to withdraw deposits from these vulnerable countries, creating a potential for bank runs to add to economic instability."

The outlook then continues by revealing a possible result of any eurozone exit is "wealth destruction" and "deep depression".

"If everything came to a head, with governments and banking systems under extreme pressure in some or all of the vulnerable countries, the political fall-out would be dramatic and pressures for euro area exit could be intense.

"The establishment and likely large exchange rate changes of the new national currencies could imply large losses for debt and asset holders, including banks that could become insolvent.

"Such turbulence in Europe, with the massive wealth destruction, bankruptcies and a collapse in confidence in European integration and cooperation, would most likely result in a deep depression in both the exiting and remaining euro area countries as well as in the world economy.

As far as I know, this is the first time a major public sector organisation has mapped out the possible consequences of a euro break-up (though a couple of investment bank economists have had a go).

Of course, it’s terrifying stuff. And what’s perhaps most worrying of all is that we still have yet to see any change in stance from the euro leaders with the wherewithal to do something about it - Angela Merkel and (to a much lesser extent) Nicolas Sarkozy.

With every day that goes by without action to calm investors, who are now openly panicking, the kind of scenario mapped out above become more likely.

Lest we forget, the great depression may have been sparked initially by the Wall Street crash of 1929, but it was the collapse of Europe’s banking system two years later that really cemented the decade of economic misery and suffering. We must hope Europe’s leaders are really awake to the threat.