"Either we’ll see a massive new plan to stop the contagion in Europe or the contagion will spread with failing banks nationalized as the Euro is dismantled. If this is
allowed to happen it will lead to a deflationary recession or possible depression in the Euro-Zone and beyond. Tragically this is all preventable, yet the leaders of Europe sit frozen in their own inaction to address their fundamental problems. Stop-gap measures such as the coordinated international injection of liquidity just employed is important defensively, but only buys time.
Most likely, real action will come only at the point of panic. There is nothing like panic to focus the mind. If the market loses confidence in the government’s ability to pay their bills or questions the solvency of banks, the ball game is over. Confidence is the only thing tying the Euro-Zone together. The consequences of failure would be extreme, which is why we should take a little time to review and prepare for the various scenarios and possible outcomes if this happens.
The
first and most likely scenario if panic should set in is that free-falling markets and spiking interest rates would quickly force the governments of the world to step up and throw everything they have at the markets. At that point, all of the plans they have been talking about but unable to agree upon would come together. So, no doubt an international response would be volleyed to try and stop the panic. Their attempt might work—and might not. We just saw evidence that all nations including China are willing to participate in such an attempt. This is at least a first step. China adds to the "Bazooka effect".
What do they have in their arsenal? They can
inflate. The ECB could inject massive amounts of cash into the banking system, even though they are not suppose to. The IMF could create reserves in the form of SDR's to serve as an asset backed by a basket of currencies, and then loan these to governments, an even greater inflation weapon. They also have gold in their coffers which can be used as collateral. And they have the ability to borrow from those that have cash such as China or Brazil, whom they are courting.
Finally, they could
restructure their debt through amortization or forgiveness at below market interest rates for longer periods of time. If all these efforts failed to stabilize the system they have
brute force at their disposal and can impose capital controls, shut down markets, close and nationalize banks, and impose higher taxes.
Scenario number two is that
the Euro breaks apart as Greece returns to the Drachma and other hopelessly indebted nations do the same. OR...Germany does the splitting by returning to the Deutsche Mark and refusing to continue support to the weaker countries. One route leads to devaluation and the other to revaluation of currencies, but both would end in major defaults and reversals of trade flows. The German surplus would dwindle and the Greek trade deficit would turn to surplus, but at the end of the day it would primarily be the creditors who suffered the losses together with importers or exporters. Historically, when push comes to shove, debtors win over creditors. This is in my opinion why we have seen bank stocks falling throughout the world -- they are volnerable.
A third scenario is that
the status quo just continues. The Euro-Zone buys more time through the application of various half measures and Band-Aids until they eventually get their financial house in order. Fiscal austerity would need to be the order of the day throughout Europe. That could take about
five years to accomplish if they are sincere about cutting spending. Assuming they eventually subsidized all financial losses, the price tag, as I see it, would be upwards of
three trillion dollars, include a
prolonged recession, and a
falling Euro.
In addition to these three scenarios there are all the
“Armageddon” prophecies that include the breakdown of the monetary system, hyperinflation, or a deflationary depression with all of the social unrest that comes with the breakdown of societies..."
http://www.kitco.com/ind/Nathan/dec092011A.html
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