OPINION:THE PROBABILITY of a break-up of the euro has increased significantly in recent weeks as the centrifugal forces rending Europe's monetary union have grown stronger. Economic, financial and political conditions are all deteriorating, and each is feeding off the other.
This has culminated in questions being posed among those who call the shots in Europe about shrinking the euro zone from its current 17 member countries. In Cannes two weeks ago, the French president publicly contemplated a country exiting the currency union. Last week, multiple official sources told Reuters news agency that plans for a smaller currency union of core northern European countries were being considered.
Raising these possibilities gives the core countries leverage over the peripherals. Such leverage is needed because the absence of credible sanctions was one important reason the Papandreou and Berlusconi governments felt able to renege on commitments they had made to the rest of the euro zone.
But raising the issue of a possible break-up also signals a weakening of the commitment of the core to the euro as it currently exists. In the absence of new commitments, such as a stepping-up of the European Central Bank’s response to the crisis, the only logical conclusion is that some, many or all of the core countries are reassessing their interests in preserving the status quo.
That has added momentum to a vicious cycle that is at risk of becoming a death spiral for the euro. What are the likely outcomes of the crisis?
Few possibilities can be ruled out, including measures for which legal provision do not exist. Many people correctly point out that there is no legal mechanism in EU treaty law to dismantle the euro, or for countries to leave/be ejected from the single currency. But this should not give false comfort. If a crisis of any kind becomes sufficiently threatening, ways can be found to circumvent legal constraints. Ultimately, in the case of Europe, sovereign states can abrogate EU treaties.
On Monday the German chancellor said that Europe faces its gravest hour since the second World War. To say this of a Continent that has suffered very serious crises since 1945, including going to the brink of nuclear annihilation, illustrates how threatening Angela Merkel believes the current situation to be. “If the euro fails, Europe fails,” Merkel has said repeatedly. It is not unreasonable to interpret this new maxim as a signal that Germany’s position on the EU is dependent on the survival of the euro.
If it comes to a sea change in Europe, there are three broad possibilities: the departure or ejection of one or a small number of countries from the currency union; the formation of a smaller currency area comprising the northern creditor countries; and complete fragmentation back to national currencies.
The first option would only add to the centrifugal forces already at work. The departure of Greece and Portugal – the two economies whose fundamentals are least suited to currency union – would almost certainly trigger a full-scale run on Italy, Spain and Ireland, as the prospect of their departure would immediately increase. That would feed into the core via the banking system and contagion effects. In short, any attempt to unpick part of the euro would probably lead to the entire project unravelling.
The second possibility is for a much more profound change to be attempted, involving the stronger northern European countries forming a new currency union. There are many reasons to believe that this will not happen, above and beyond the cataclysmic impact it would have on the periphery and feedback effects on the core.
The purpose of the euro was primarily to bind Europe more closely together. All EU member states are bound to join (Britain and Denmark are the exceptions, having negotiated their opt-out two decades ago). A core euro would necessarily be an exclusive club, with no prospect of membership for those not invited to join.
Europe has always worked on the basis of inclusion, never on the basis of exclusion. If there was any attempt to make it work exclusively, it would become a cause of division, not a driver of unity. Why would countries who have made such a long-term strategic commitment to inclusive unity suddenly shift to the opposite extreme?
Moreover, it is not at all clear that many of the countries deemed worthy of participation would want to join a core euro. Finland and the Netherlands would almost certainly not. If the German people had any say in the matter they would ask for the deutschmark back.
Two other reasons militate against a core euro. One is economic. Since its launch in 1999, the euro has made the bloc a little more prosperous (by generating trade and investment that might otherwise have not been generated), but even the currency’s most ardent advocates would not claim the gains have been anything more than marginal. The crisis has shown that whatever the benefits of full currency union, they do not outweigh the costs and risks. Why, then, go from one currency union to another?
The absence of the institutions required to run a currency among the core countries also makes that outcome very unlikely. Not only would a new central bank be required but, as such a currency union would have to be established outside EU architecture, other institutional structures would be needed too. These could not be established over a weekend.
If the euro breaks up, the most likely outcome by far is the relaunching of national currencies: in part because European-level solutions will have been so badly discredited; in part because all the member countries retain the institutions necessary to do so; and in part because it is the option that can be exercised most rapidly.
With the euro crisis now deep into endgame, Europeans face the choice of a radical deepening of their commitment to preserving their currency or its uncontrolled unravelling. Time is running out. Decisions cannot be postponed much longer.