How an attack on Iran could kill the euro

China has waded in with words of warning about the dangers to the world economy of Israel attacking Iran. But it's the EU that should worry

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The Commentator
On 6 April 2012 08:58

It is being widely reported today that a senior Chinese diplomat has issued a stark warning about the consequences for the world economy of Israel attacking Iran's nuclear facilities.

The head of the Chinese foreign ministry's West Asia and North African affairs division, Chen Xiaodong, said: "If force is used on Iran, it will certainly incur retaliation, cause an even greater military clash, worsen turmoil in the region, threaten the security of the Strait of Hormuz and other strategic passages, drive up global oil prices and strike a blow at the world economic recovery."

Whether he's right about Iranian retaliation is debatable. Much would depend on the level of backing Israel got from the United States and Europe. If they're resolute in Israel's defence -- and fat chance in the latter case -- Iran might well think twice about engaging in a major conflagration it would ultimately lose.

Soaring oil prices is the easiest outcome to predict should Israel attack (See our owner/publisher here explaining recently why it's possible that Israel could strike Iran before the US elections in November.)

And though China and everyone else would suffer from a sharp spike in the price of oil, it is Europe, and especially the euro, that would probably suffer the most.

Think of it this way: the euro will be lucky to have survived the shock of the (ongoing) financial crisis. Yet another external shock would probably kill it. Greece and much of southern Europe is already on its knees. These countries have little prospect of long term recovery anyway due to structural flaws in the single currency that have effectively condemned them to penury. But if oil prices double, their economies will risk collapsing, and there simply won't be enough money to bail them out.

At that stage it would surely be obvious that the ability to devalue their currencies would be the only way to get them back on their feet. In other words, they'd leave the euro.

At some point, the markets are going to get the point. And even though there is no certainty about an Israeli attack, the risk is sufficient to adjust their positions now. Our view has long been that you'd have to be mad to buy (or even retain) southern European debt. But with the rising tension in the MidEast and the relative ease of the scenario building, it is surely time to take action now rather than complacently wait and see.

If markets do react according to such calculations this could all become a self-fulfilling prophecy. And the euro could be history long before anyone thought possible, and regardless of what Israel actually does about Iran.

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