T

he euro area has a scent of political revolution in the air. France’s Presidential election saw Sarkozy rejected and the Socialist contender Hollande replace him. The Greek general election has produced a result of supreme incoherence.

The Dutch are without a proper government, the Irish are holding a referendum on fiscal austerity, and Italy is governed by an unelected Prime Minister. What is happening? And should Asia care?

Elections should not be viewed as votes on a single issue. Greece has not voted to reject the Euro. France has not voted to change its relationship with the rest of the eurozone. The motives for voting are complex. The fact that Greece saw electoral success for parties hostile to the euro bail out and austerity measures does not mean that the population at large shares that overall hostility to the same degree.

The current political climate is anti-incumbent. People are not necessarily voting “for” something. They are voting against what currently exists. There are good reasons for that. What exists at the moment in many parts of the Euro area is very unpleasant. The fault for this lies with politics.

Politicians created a monetary union that does not work. Politicians ignored the explicit advice of economists, who said it would not work. A politician once told me “politics will lead, and the economics will follow along after”. Unfortunately for Europe that is not correct. The economics of the Euro have always been bad, and economics is leading politics.

So what does this mean? I would assume the Euro survives — with seventeen countries. The cost of a Euro break up is too horrendous to be considered. The idea that a single country could exit is complete nonsense, in my view. If one country goes, other countries will go as well — the euro area will be powerless to stop the contagion. If the Euro does break up, then the outcome will be disastrous for the global economy — and Asian economies will suffer as much as any other economy.

A euro break up would be like the Lehman failure, only on a larger and more complex scale. Banking systems would be exposed and trade finance would disappear. Companies would default on their debts. If the monetary union fragments, contracts are not honored — or are not honored in the currency or with the value that counterparts had expected. Banks outside of the Euro area with exposure to the Euro area banking system, or with exposure to other banks that are in turn exposed to the euro area banking system, suffer losses and illiquidity.

Assuming that the disaster is avoided and that the euro survives, what is likely to happen? I believe we face a prolonged period of political uncertainty, with national politics working both for and against the essential integration that can preserve the euro. While this uncertainty persists, I believe three trends will be observed.

First, the euro area economy is going to be weak. Political uncertainty does not help economic growth. This year’s recession may not last into 2013, but growth will be poor for some years. Some countries within the euro will be stronger than others, but in aggregate growth will be weak. As this is the second largest economy in the world, and a major export market for Asia, this is of considerable importance. Asia can not rely on Euro area demand.

Second, euro area capital is more likely to stay at home. With euro political uncertainty and volatile financial markets the war for capital is likely to escalate, and euro area governments will be at pains to keep as much of their capital as they can at home for their own consumption. The euro area is almost as important a source of capital as is the United States. The loss of this capital will be felt in Asia.

Third, Asia will have to learn to love the dollar. In the past, Asian companies selling to the euro area have been content to accept euros for their exports. The euro crisis has led to a shift. Companies are now reluctant to accept Euros — either because they fear that the value of the euro will decline because of the political instability, or because they fear the possibility (however small) of a euro break up.

Few Asian companies are likely to be terribly happy if they are offered a Greek euro in settlement of an invoice. Asian central banks may want to rethink their policies of currency diversification away from the dollar, if the dollar is going to become more important to their exporters.

So the political revolution in Europe matters. Uncertainty is likely to persist for years to come. This will impact Asia. A revolutionary Euro area is a negative shock, and Asia must adapt.

The writer is Deputy Head of Global Economics, UBS Investment Bank.