Eurozone leaders face some tough choices over the coming months, a break up of the euro or fiscal union via eurobonds. Neither option is attractive but which path will they choose?

The first option, breaking up the euro would probably occur by individual countries deciding to leave (or be expelled from) the euro. Presumably this fate would befall the weaker countries, who would then default on their borrowing and attempt to start again. Whilst this might seem attractive on the face of it, the reality is that these countries would face real austerity and a huge drop in living standards. They would however be in control of their own fate rather than be constrained by the rules of the Eurozone.

But what of the strong countries left in the Eurozone, what would be the effect on them? The value of the new euro replacement would soar in value. A euro comprising of Germany, France, the Benelux countries and Finland is estimated to appreciate by 30% virtually overnight. This would be disastrous for these economies who would face a corresponding 30% hike in their export prices. 

Another consequence of the strong euro nations jettisoning the weaker ones would be the consequence of the defaults that would occur. Collectively the weak nations owe the stronger ones (i.e. German and French banks) a colossal 2 trillion euros. In default, the banks would have to be bailed out and it is estimated that this would cost each German household around 6000 euros.

A break up of the euro would be disastrous not only for the weak countries but for the stronger ones as well. A fact that isn’t much appreciated currently is that Germany benefits hugely from the relatively weak euro to keep the cost of their exports down, giving them a huge competitive advantage internationally.

So what of the alternative, fiscal union? Under fiscal union Europe would effectively become one state, with the stronger countries inherently guaranteeing the debts of the weaker ones. Fundamentally this is the direct consequence of issuing Eurobonds. But why should the tax payers of strong fiscally responsible countries like Germany agree to this? Why indeed when the widely held view is that the largely southern European countries are feckless spenders who cannot control their budgets or adequately raise taxes? The answer is; because the stronger states would lose so much more by not doing so. Firstly, a default (orderly or otherwise) would mean that the governments of Germany and the other creditor nations would have to step in to bail out their own banks who have lent most of the 2 trillion Euros currently owed. Secondly as pointed out above whatever new currency the strong nations use as an alternative to the current euro would soar in value making exports uncompetitive (a problem the Swiss are currently experiencing). Thirdly, the world would be plunged into a very much deeper recession as depreciation took hold through southern Europe and ultimately this would be very damaging to the northern European countries as well.

Unfortunately for German taxpayers the choices are stark, allow the euro in its present form to break up and face economic ruin or take on the debts of southern Europe and face a decade of slowly sorting out the mess. Neither option is attractive but perhaps the second is the lesser of the two evils.  I suspect that the eventual solution will turn out to be a hybrid of what I have set out above but there is perhaps a silver lining amongst the current clouds of grey and that is that matters are finally coming to a head and an outcome of some sort will soon be upon us.