The Euro

Common Currency's Existential Crisis

10 euro note close up

Welcome back, euro! For a while there, you looked like a goner. During those debt crisis days in 2012 when Greece was imploding and Spain’s banks were teetering and the Germans were asking why they had to pick up the bill, there was a serious wobble. Common European currency? Remind us, please, what Europeans actually have in common. And now that economic growth in the countries sharing the euro is stagnating and Greece is in political upheaval again, there’s a reminder of how many problems it caused. The question is being raised once more: Can the world’s most ambitious financial experiment survive?

The Situation

Greece’s anti-austerity protest party Syriza was swept to power in a Jan. 25 election, pledging to write down the country’s debt and abandon budget constraints imposed in return for aid. While most Greeks don’t want to leave the euro, the new government’s defiance revives the risk that Greece will exit the bloc. At the same time, countries like France and Italy are also pushing the European Union to relax budget rules or give them more leeway to boost spending to help sagging economies. The 19-nation currency bloc is forecast to expand just 1.1 percent in 2015, about a third of the 3.1 percent pace in the U.S. Euro-zone unemployment has held close to a record 12 percent for two years, with about a quarter of young workers unable to find a job. The European Central Bank cut a key interest rate below zero in June and unveiled a plan in January to buy government bonds to help rekindle growth and combat deflation, or a slide in prices. The prospect for more stimulus sent government bond yields in the euro zone (excluding Greece) to record lows in early 2015 as the euro slid to its weakest value against the dollar in more than a decade.

Source: European Commission estimates as of November, 2014
Source: European Commission estimates as of November, 2014

The Background

The EU was set up in 1958, as the continent’s leaders vowed to make another war between them all but impossible. The euro came 41 years later, when a group of 11 countries jettisoned marks, francs and lire and turned control of interest rates over to a new central bank. The common currency’s scale provided better access to world markets and exchange-rate stability. It did not, however, impose uniform financial discipline; to avoid surrendering national sovereignty, politicians largely sidestepped a unified approach to bank regulation and government spending. While there were some rules, they were flouted. The crisis that brought the euro to its knees came during the global rout in 2009, when Greece acknowledged its budget deficit would be twice as wide as forecast. Investors started dumping assets of the most indebted nations and borrowing costs soared. The shared euro made it impossible to devalue individual currencies of weaker countries, limiting options for recovery. Politicians lurched through bailouts for Greece, Ireland, Portugal and Cyprus plus a rescue of banks in Spain. The panic fueled fears of a euro breakup as fragile banks exposed the common currency’s flaws. The firestorm abated in July 2012, when ECB President Mario Draghi pledged to do “whatever it takes” to preserve the common currency.

The Argument

Euro-area leaders say the worst is over. New systems have been put in place to centralize bank supervision and build firewalls between troubled debtors and taxpayers. They still may not have gone far enoughProposals for a deeper union — including more oversight of national budgets and the pooling of debt — have not been realized and could sow the seeds for another crisis.  The diverging fortunes among countries in the bloc highlights the challenge for the ECB, which is concerned adding stimulus could undermine efforts to make laggards rein in spending, or fuel asset bubbles. And even though a potential Greek exit from the euro poses less systemic risk now than in 2012, the uncertainty has revived speculation about the staying power of weaker members. Existential doubts about the common currency remain.

The Reference Shelf

First Published April 10, 2014

To contact the writer of this QuickTake:

Ian Wishart in Brusssels at iwishart@bloomberg.net

To contact the editor responsible for this QuickTake:

Leah Harrison Singer at lharrison@bloomberg.net