The Euro

Common Currency's Existential Crisis

10 euro note close up

Hey, 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 Greece is back from the brink again and economic growth in the countries sharing the euro is still sluggish, there are regular reminders of how many problems it causes. The question is being raised once more: Can the world’s most ambitious financial experiment survive?

The Situation

Greece surrendered to the demands of euro zone leaders July 13 to qualify for another bailout and remain part of the common currency. Months of increasingly bitter disagreement and Germany’s insistence on more austerity had eroded confidence that a solution could be found, but not before record withdrawls from Greek banks prompted the government to shut lenders, close its stock market and impose capital controls. Although it represents just 1.8 percent of the output of the bloc, a Greek exit from the euro would discredit euro-area leaders who insist that the common currency can’t be dismantled. Separate from the crisis in Greece, countries like France and Italy have pushed the European Union to relax rules and give them more leeway to boost spending to help sagging economies. The 19-nation currency bloc is forecast to expand just 1.5 percent in 2015, about half the pace of the U.S. Euro-zone unemployment has held close to a record 12 percent for three years, with just under a quarter of young workers unable to find a job. The European Central Bank cut a key interest rate below zero in June 2014 and began buying government bonds in March, which has helped growth recover somewhat. The slump has fueled a surge in support for anti-EU protest parties across the continent.

Source: European Commission estimates as of May, 2015
Source: European Commission estimates as of May, 2015

The Background

The precursor to 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 that 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 economies, 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 vulnerabilities. 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 that even if Greece were to fall out of the euro, the common currency would survive. New systems have been put in place to centralize bank supervision and build firewalls between troubled debtors and taxpayers. The measures 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 the euro’s flaws could sow the seeds for another crisis. Even though a Greek exit from the euro poses less systemic risk than in 2012, no one quite knows what the economic and political consequences would be. 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.  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