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What if the euro fails?

Euro
Highlights
  • The likelihood of a full-scale collapse of the euro remains very remote.
  • More likely is a scenario in which some weaker countries exit the euro.
  • Countries converted into the euro, so they ought to be able to convert out.

When the European sovereign debt crisis began in late 2009, few experts believed it would bring about the demise of the euro, a currency used by 17 of the 27 European Union countries. But today, with a steady stream of bad news coming from Europe, speculation has grown -- at least in some circles -- that the euro's days might be numbered or at least that a handful of the most troubled countries like Greece might exit the euro and use their own currency going forward.

"The likelihood of a full-scale collapse of the euro remains very remote," says Werner Bonadurer, a clinical professor of finance at the W.P. Carey School of Business at Arizona State University in Tempe, Ariz. "But the impossible has become possible, and it is necessary to think about the unthinkable."

Preparing for the unthinkable

Taken as a whole, Europe represents America's largest trading partner. "The most common currency for transactions between U.S. and European businesses is the dollar," says James Sagner, associate professor in the School of Business at the University of Bridgeport in Connecticut. "But the euro is a close second, and that leaves anyone doing business with Europe very exposed."

Part of the problem is that uncertainty about the euro's future is driving the currency's value down relative to the dollar, Sagner says. Currently, the euro is trading near its 52-week low, and many economists believe the dollar and euro may eventually trade at a 1-to-1 ratio.

"If you made a deal to be paid in euros, you're losing money right now," Sagner says.

Going forward, you have a few options. First, American businesses can always write contracts that specify payment in dollars. Or, those companies can buy so-called forward contract, which lock in a future price for the euro, he says.

"You'll pay a little more for a forward contract, but if the price drops dramatically, you won't be affected," Sagner says. "(As is), small- and medium-sized businesses don't have experience with forward contracts, and you generally find that only the larger banks even offer the product."

What happens next?

"There are a lot of possible scenarios," says David Song, a currency analyst for DailyFX in New York. "None of them are very good."

Broadly speaking, the euro faces several possibilities.

A total collapse, which experts like Bonadurer stress is remote, could trigger a far-reaching catastrophe.

"Such a collapse would lead to a multiyear depression in Europe and several years of recession in the U.S.," Bonadurer says.

But it wouldn't be a typical recession in the U.S., says Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco.

"Collapse of the euro would have a worse impact on the U.S. economy than the Great Recession because it would produce an even greater one worldwide," Connelly says. "A rush of financial assets out of the eurozone would play havoc with currencies and the price of oil."

Even worse, Connelly predicts a collapse also could destroy interbank lending worldwide. A run on banks around the world would freeze credit markets, making it difficult for businesses to borrow money. But unlike a similar crisis in the U.S. in 2008, Connelly says "there really is no road map" for saving the global banking industry because there's no single global entity that wields as much power internationally as the U.S. Federal Reserve does domestically.

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