Survival: Global Politics and Strategy, vol. 51, no. 2, April–May 2009, pp. 41–54
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The global financial crisis is the first major challenge for the euro as a multi-national currency. Many wonder whether it will also be the last. Although early indications suggest that the eurozone countries are weathering the storm, this has not stopped prominent economists such as Martin Feldstein from cautioning that ‘the current financial crisis may provide a severe test of the euro’s ability to survive’.
This is not the first time that Feldstein has issued such a warning. He published an even stronger statement in the pages of Foreign Affairs shortly before the euro was formed. Then he speculated that conflicts between participating countries, or between those inside and outside the euro, could even escalate to war. Few took the prospect seriously, either during the launch of the single currency or in the years that followed. As the current crisis continues to deepen and popular protests begin to mount, however, many fear Feldstein’s nightmare scenarios are no longer so absurd. War is not on the cards, but a deep and divisive conflict over the functioning of the single currency cannot be ruled out. Such a conflict would not only set European countries against one another, but could also undermine the solidarity of the European Union as a whole.
In an effort to determine whether the survival of the eurozone is threatened, commentators have naturally turned to the economic data. What they find is troubling. Real unit labour costs relative to major trading partners (a rough measure of national competitiveness) are moving against some of the poorer southern countries of the eurozone, Italy in particular. The same is also true for some countries outside the eurozone, such as the United Kingdom. The difference is that these countries at least retain the ability to restore national competitiveness by devaluing their national currencies.
A further problem is that the poorer and more highly indebted countries of the eurozone are witnessing an increase in the relative cost of long-term sovereign borrowing. The difference in the yields on ten-year benchmark government bonds between Greece and Germany, for example, has increased by a multiple greater than five. Again, borrowing costs are rising for some countries outside the eurozone as well, but they have control over their own monetary policy and so – at least in extremis – are able to print their own money and inflate away the difference. Countries that have adopted the euro do not have this pressure-release value. Hence the threat is not so much that countries will leave the eurozone but that they may default. The only hope defaulters can have for salvation lies in the possibility that the richer countries such as Germany will find the economic resources and political will to bail them out.
The closer one looks at the problem, the worse it becomes, particularly if the economic data are to be believed. Nevertheless, there is good reason to believe that the situation is much better than most commentators are willing to admit. The trick is to dissect the economic analysis...
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Erik Jones is Professor of European Studies at the SAIS Bologna Center of the Johns Hopkins University and a Contributing Editor to Survival. He is the author of Economic Adjustment and Political Transformation in Small States (Oxford University Press, 2008).
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