There are increasing signs that Germany is making emergency preparations in case the country feels it has no other choice but to leave the euro and go back to the mark. Although Angela Merkel is officially 100% committed to the ideal of a united Europe, behind the scenes Germany seems to be preparing for the possibility that it might have to abandon the euro.

The reason for this is the ongoing debt crisis in some of the smaller EU nations. This week eurozone finance ministers will once again meet to make a decision on whether Greece has satisfied the conditions for its next bailout loan.

If Athens does not receive the €130 billion in bailout money, it will most likely be unable to stave off bankruptcy in mid-March, when the next large repayment on its government debt has to be made. Harvard economist Ken Rogoff is of the opinion that Greece is going to default, no matter what.

Germany’s conundrum

The problem for Germany is that France wants to save the euro at all costs, even it if means borrowing even more to re-capitalise the European Rescue Fund. Germany, on the other hand, is simply no longer prepared to accept the responsibility for smaller countries’ debts, without gaining more control over their fiscal affairs.

The overall EU debt/GDP ratio is a relatively manageable 88%, so with proper central fiscal control there is no reason for the EU to go down. This would, however, come with a price tag, in the form of a loss of individual countries’ control over their fiscal budgets.

Two choices for Germany

In the end Germany might only have two choices:

1. Stay in the euro and accept the risk that it could have to play a significant role in funding the debts of struggling economies, such as Greece, Italy and Spain
2. Leave the euro and face the consequences

The cost of leaving – or staying

If Germany leaves the euro, some economists predict that the value of the currency would fall by as much as 50%. The mark, on the other hand, would rise significantly against the euro.

This might not be what German industry wants, however. The country’s exports would immediately become more expensive, which would have a negative effect on the balance of trade with the rest of the world. Cheaper imports would put additional pressure on domestic manufacturing industries.

Loans to other countries, granted in euros, would also immediately drop in value, meaning Germany could, in real terms, get back considerably less than their original value.

If countries such as Spain, Italy and Greece remained in the EU, it would mean their products and services would immediately become cheaper relative to those of their German counterparts, which would have the effect of stimulating their economies.

Trading opportunities

Germany’s departure could be a goldmine of opportunities for traders. The scenario we saw in the chart below, between the end of October last year and the middle of January this year, would most likely continue.

The euro would be virtually certain to drop against the mark and other major currencies for a prolonged period of time, creating a great opportunity for going long on the mark, USD etc and simultaneously going short on the euro.

Published: 21 February 2012

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.