Welcome back, euro! For a while there, you looked like a goner. During those debt crisis days 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, there’s a reminder of how many problems it caused. That’s also raising the question again: Are the flaws in the world’s most ambitious financial experiment fixed for good?
The euro had its biggest annual gain in six years in 2013 as the currency bloc emerged from its longest-ever recession and investors flooded back in. Ireland, Italy and Spain sold government bonds at record low yields this year. Even Greece, which briefly flirted with the idea of bringing back the drachma at the height of the crisis, ended a four-year exile from international markets with a bond sale in April. Even so, it’s not all positive. The economy of the 18-nation bloc is forecast to expand just 1.2 percent this year, less than half the 2.8 percent pace in the U.S. Banks are still reluctant to lend. Unemployment remains close to its record at about 11.5 percent and about a quarter of young workers can’t find a job. What’s emerging is a multispeed recovery, with newer members like Estonia and Latvia creeping forward, while Italy contracts again and growth in France halted. The slump has prompted the European Central Bank to cut a key interest rate below zero and plan to buy securitized debt to help boost lending.
The European Union 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 Germany and France led a group of 11 countries that jettisoned marks, francs and lira and turned control of interest rates over to a new central bank. The scale of the common currency provided better access to world markets and more 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 the 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, with the EU and the International Monetary Fund committing a total of 496 billion euros ($687 billion). The panic fueled fears of a breakup as high debt, real estate bubbles and fragile banks exposed the common currency’s flaws. Banks and companies began to prepare for the return of currencies that might fall out of the euro. The firestorm didn’t abate until July 2012, when ECB President Mario Draghi pledged to do “whatever it takes” to preserve the euro. The promise bolstered confidence that conditions for funding backstops would be met.
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 enough. Proposals for a deeper union, including more oversight of national budgets, binding agreements to make economies more competitive and the pooling of debt have not been realized and could sow the seeds for another crisis. The diverging fortunes among countries highlights the challenge for the ECB, which is battling the threat of deflation, or a drop in prices, which could be a drag on growth for years. Adding stimulus to aid laggards could undermine efforts to make them rein in spending, or fuel more asset bubbles. Though the bloc has survived the crisis so far and existential doubts about the common currency have faded, the euro still faces plenty of longer-term risks.
The Reference Shelf
- Angela Merkel: A Chancellorship Forged in Crisis, a book by Alan Crawford and Tony Czuczka.
- Bust: Greece, the Euro and the Sovereign Debt Crisis, a book by Matthew Lynn.
- ECB President Mario Draghi’s July 2012 speech pledging to do “whatever it takes” to save the euro.
- European Commission’s November 2012 blueprint for a deeper economic and monetary union.
- Bloomberg QuickTake on the plan for Europe’s banking union.