Just the fact that I’m asking this question shows how bad off the 17-nation currency actually is. As the euro-zone debt crisis enters its third, uncertain year, the euro could face its biggest challenge yet. Italy’s bond yields remain unsustainably high, testing new Prime Minister Mario Monti’s pledges to reform the stagnant economy. Spain’s new government continues to cut into the national budget, even though unemployment stands at a staggering 23% and the economy is likely contracting. France is scrambling to keep its AAA credit rating. Greece, well, is Greece. The anti-euro voices in European politics are growing louder and more influential. No wonder, as the Wall Street Journal reported recently, two global banks took steps to recreate trading systems that could handle Europe’s many original national currencies, just in case the euro collapsed.
So will the citizens of Europe still be carrying euro bills in their wallets next Christmas? Or will they be replaced by marks, francs and lira?
One of the more fascinating aspects of the European debt crisis has been the resilience of the euro. For much of 2011, the euro was the Teflon currency, oblivious to the chaos ravaging Europe’s economies — the upheaval in bond and stock markets, the grave concern over the health of the banks, the worries of a Greek default, the contagion to Italy and the uncertainty over the future of the monetary union itself. Now, however, the gravity of the crisis is finally dragging down the euro. The common currency touched a 16-month low against the dollar the other day. And there is growing consensus in financial markets that the slide is very likely to continue. Added to the ongoing concerns about the debt crisis and possible downgrades for countries like France, the euro-zone economy seems headed for a painful recession in 2012. Add in signs that the U.S. recovery is building, and there seems to be little to hold the euro up. Here’s one outlook from research firm Capital Economics:
The relative strength of the recent economic data from the US is supporting the dollar more generally, and we expect this divergence to persist as the euro zone slides into a deep and prolonged recession. Above all, doubts about the very survival of the euro itself are likely to remain a drag on the currency. We therefore continue to expect the euro to fall to around $1.10 by the end of the year.
Of course, we’ve heard this before. Capital Economics forecast the euro would go to par with the dollar back in 2010. I was guilty myself of predicting doom for the euro in a TIME magazine column in May 2010. “Don’t expect the euro to reverse course anytime soon,” I wrote. Of course, that’s exactly what it did. Ugh. I hate being wrong. I failed to foresee a few important factors that gave the euro new life: 1) the Federal Reserve’s extensive and unconventional efforts to bring down interest rates (the QEs), which flooded the world with dollars, weakening the greenback; 2) the European Central Bank’s (ECB) irrational obsession with inflation, which caused it to raise interest rates amid the debt crisis, supporting the euro relative to the dollar; 3) nations with current-account surpluses and large currency reserves (especially China) still need to park all that cash somewhere, and in an effort to diversify, they won’t keep it all in dollars, making the euro more attractive than it should be.
Now, though, at least two of those elements are gone. The ECB has started cutting rates again as the euro zone sinks into recession. And with further shocks almost inevitable — can France really keep that AAA? — the euro will get knocked around again and again.
Of course, a weak euro is good for a Europe struggling to find growth. Germany’s already highly competitive export sector will only get more competitive with a cheap euro. Yet a deteriorating euro will weigh on sentiment. If the euro loses value, it could only feed doubts about its medium-to-long-term survival.
But a weakening euro doesn’t necessarily translate into a dead euro. Despite its problems, there is still widespread support for the euro in European capitals, and that has led HSBC to recently proclaim that the euro is “here to stay.”
The objective of European economic integration was born out of a response to the horrors of the two world wars … Monetary integration has long been seen as essential to making overall European integration work, and the response to a variety of crises over the past thirty years has been to move towards ever closer integration. The response to the latest crisis should be seen in this context — a move towards closer fiscal integration (at least for most EU members).
Ah, here we get to the heart of the matter. At the end of the day, what will decide the fate of the euro in 2012 — and even its survival — is whether or not Europe’s leaders can match their verbal commitment to the monetary union with real commitment. The whole reason I’m writing this column today is because that hasn’t happened. European governments have failed to implement stated agreements — on boosting the power of the bailout fund, for example, or restructuring Greek debt. Meanwhile, they’re forging ahead with even more complicated new ones, to toughen fiscal controls on euro-zone members by altering E.U. treaties, for instance. Will that really happen, and when, and can it make a difference in the crisis today? Now German Chancellor Angela Merkel and French President Nicolas Sarkozy are talking about coming up with a plan to spur growth as a “second pillar” to fight the debt crisis. That’s a good idea. So where is it? As usual, there’s a whole lot of blabber about fixing the euro and not a lot of actual doing. Thus the risk will remain firmly in place that eventually a member of the zone will decide the costs of the euro are outweighing the benefits, or the desirability of integration. That country could be an indebted one, like Greece, that decides the pain of adjustment is too great to bear, or a better-off country that decides the burden of supporting the euro is too hefty or too unpopular.
The fact is that Europe’s leaders continue to dodge what really needs to get done to stabilize the monetary union — the formation of a true fiscal union, debt consolidation, and the development of a growth strategy. How can Europe expect investors around the world to have confidence in the euro when they don’t meet their own commitments to the common currency? That’s the bottom line. If the euro is to survive the debt crisis, Europe’s leaders will have to dispel the continuing doubts about its survival. Until that happens, the euro can never truly be safe. I wonder if I have some old drachmas stashed away somewhere.