Global Economics

Soul Searching in the Euro Zone


The future of the European common currency has never seemed shakier after the crisis precipitated by Greece's yawning budget deficit and spiking bond yields

Some of Britain's most eminent economists and financial figures put their names to an article in 2002 entitled "Why Britain should join the euro"

The list of luminaries detailing their support included Willem Buiter, a former member of the Bank of England's Monetary Policy Committee, Will Hutton, former chief executive of the Work Foundation, and Adair Turner, now the chairman of the Financial Services Authority. Paul Volcker, an economist and a key lieutenant of President Obama, also added his name to the study.

"There are, of course, pros and cons of joining the euro," concluded the group at the time. "But we believe the arguments in favour are much the stronger. And the time to join will soon be upon us."

Just last year, the Business Secretary, Lord Mandelson, extolled the virtues of the euro saying it was "perfectly clear that the euro had been a great success in anchoring its members during the financial crisis".

Given the travails of the euro over the past few weeks, it's hard to believe that support for the single currency would now be as forthcoming.

Quite simply, the European project has teetered on the edge, pushed to the brink by a failure of the Greek economy of truly tragic proportions.

Greece's economy is running a deficit of nearly 13 per cent, according to official figures, which equates to roughly €21bn (£18bn). The investment bank Goldman Sachs (GS) has suggested the Greek economy is in a worse position, with €33bn needed to plug the shortfall between tax receipts and spending.

Under the terms of the European Union's Stability and Growth Pact, countries must run balanced budgets over the course of a cycle and, crucially, must keep annual deficits at no more than 3 per cent of output. Greece's government has pledged to adhere to the rules of the euro game by 2012, promising draconian cuts in fiscal expenditure.

But the markets have dismissed the chances of Greece keeping its word, prompting bond traders across the globe to sell off Athens's debt. In turn, the value of the euro against the dollar fell from $1.45 to $1.37 at the end of last week. The pound has similarly appreciated against the euro.

In January, Jean-Claude Trichet, the European Central Bank's president, described Greece's possible exit from the 16-member euro club as an "absurd hypothesy". But such a notion isn't so fanciful now.

Eurozone governments, led by the French and Germans, are thrashing out the final details of a rescue package this weekend that would bail out the troubled Greeks, although doubts remain as to whether any such deal is illegal under the rules of the euro set out in the Maastricht Treaty of 1992.

"The bailout probably violated the Maastricht treaty in theory but not the spirit," says Ulrike Guérot from the European Council on Foreign Relations. "We wanted a solid eurozone and we knew back in 1992 that issues like this could arise."

If the legal hurdles are jumped – and surely they will be given the alternatives – the eurozone's other ailing economies could need propping up too. "Greece is up against the wall to a greater extent than anyone else," says Paul Krugman, the Nobel prize-winning economist. "But the Greek economy is also small. In economic terms, the heart of the crisis is in Spain, which is much bigger."

Other countries facing potential meltdown include Portugal and Ireland, which make up the so-called PIGS economies. Ireland's government has instigated a €4bn austerity package of cuts in an attempt to rein in a deficit that could spiral to more than 14 per cent this year.

"There is no way that Greece could be allowed to fail because that would be seen as rewarding the speculators," says Tony Dolphin, an economist at the Institute of Public Policy Research. "There's clearly going to have to be a change in the rules that govern the euro in the wake of the recent problems."

That the euro finds itself in such a horrible mess will come as no surprise to many sceptics who foretold of collapse many years before the currency made its debut in 1999.

The primary objection made against the euro was that monetary policy – in the main, the setting of interest rates – was wrested away from individual governments. A single rate is now set for the whole eurozone which means that countries are unable to respond to specific problems by cutting rates – as is the issue with the Greeks. One policy doesn't fit all, argue the euro refuseniks.

Even so, 11 years after the currency's debut, few could have imagined that it would unravelled so quickly.

After an inauspicious start, the euro rapidly appreciated; the currency outstripped the US dollar in the value of notes in circulation, while it established itself as the reserve currency like the mighty greenback. At the 10th anniversary of the euro, it was trumpeted in most corners of the Continent as a roaring success.

"I don't intend to name and shame those who said that Europe's single currency would be impossible, or that its introduction would be a failure," said a grinning Jean-Claude Trichet at the time. "A success indeed."

Aided by a galloping bull market, the euro was strong and stable – in contrast to sterling – enjoying widespread support from institutional investors around the world, while there was little in the way of inflation to worry about either.

But the impact of the credit crunch hit Europe hard. And countries such as Greece and Spain, both of whose economies were fuelled in the good times by cheap money, certainly cheaper than if they had stayed out of the euro, hit the buffers. Critics of the euro believe that the Greek saga bears testimony to the failure of the currency.

"It was a mistake for Greece to join the euro and it's why they're dealing with this situation now," says Simon Tilford, the chief economist at the Centre for European Reform. "We're going to have to explore splitting the euro – it's the only way to do it. But the struggling economies which would take the weaker version of the currency would have to use the opportunity of a new currency to carry out reform. The introduction of a euro 'B' is unlikely but it's easy to underestimate the risks facing the euro."

Others believe more moderate changes to the euro and the rules governing the system will be needed.

"There's bound to be a feeling in Paris and Berlin that they should have run their fingers over the books of Greece and others before they were allowed into the euro," says IPPR's Mr Dolphin. "The rules were bent too much for some countries on entry and the price is being paid. But to say this is the end for the euro is an exaggeration. The eurozone economy hasn't performed as badly as the US and UK over the recession. Greece is one bad apple. Remember, the US has California which is bust too, and nobody is calling for the break-up of the US."

Additional reporting by Greg Walton

Britain and the Euro

The UK's attitude to closer European Union has never been divided along simple party political lines. Tony Blair was closer to Edward Heath in his pro-Europeanism, while Gordon Brown has an isolationist stance that resembles that of Margaret Thatcher.

Britain's flirtation with monetary union caused one of sterling's greatest crises. Chancellor John Major took Britain into the ERM (Exchange Rate Mechanism) in 1990. But under pressure from speculators, notably George Soros, it was forced out again in 1992. The pound fell sharply and Britain's prestige took a massive hit.

Blair tried to move the Labour party towards the single currency before its introduction on 1 January 1999, but by then Brown had successfully challenged the idea. He came up with five economic tests that had had to be passed, insisting that only then could currency stability be assured.

The tests were vague, hypothetical, and subjective, allowing him sufficient wiggle room to keep Britain out of the euro while he was in No 11. Despite talk of a softening of his position, Brown was never likely to push such a potentially divisive policy when he finally became Prime Minister in 2007.

Mark Leftly

Euro Crisis in Numbers:

19.5% Highest unemployment: Spain

43.8% Highest youth unemployment: Latvia

4% Lowest unemployment: Netherlands

120% Highest public debt as share of GDP: Greece

12.7% Highest budget deficit: Greece

€300bn Debt to foreign banks: Greece


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