Will the Euro Survive?

By Andrew Zvirzdin

With its tenth anniversary on January 1, 2009, the euro has come of age. Sixteen European countries now use the euro as their national currency and the popularity of the euro for foreign reserves is on the rise. Policymakers have breathed a sigh of relief as the currency has so far withstood the current economic downturn, including crises in large multinational banks such as Fortis and Dexia.

But congratulations are premature. The euro area has yet to demonstrate its cohesiveness when confronted with the growing economic divergence of its member states and even the specter of a sovereign debt default.


This week, the S&P downgraded the credit rating for Greece's government debt, and warned that Spain, Portugal, Italy, and Ireland may soon be next. The warnings come as national governments in these countries struggle under high levels of government debt that will only increase due to the global recession. Yield spreads over German bonds have climbed to record levels throughout the euro area, implying that investors are demanding a greater return on debt to compensate for the growing probability of a breakup of the euro area or even a government default.

EU officials do not want to contemplate these scenarios, and they have little precedent or policy guidance in dealing with such possibilities. But the diverging yields on government debt are worrying, particularly as Eurozone countries are hoping to sell over $1 trillion in government debt in 2009. Even Germany has struggled to find buyers for its debt, as an auction of its sovereign debt failed last week.

Financing growing government deficits will be a difficult task in 2009, particularly for countries on the edges of Europe like Ireland, Portugal, Spain, Italy, and Greece. As fiscal policies diverge among member states, the euro will come under increasing pressure as investors contemplate a possible breakup of the Eurozone. Leaders will have to act together to show their commitment to preserving the single monetary policy in the euro area. Only after the euro has fully weathered this current recession will it deserve a birthday party.

http://newsweek.washingtonpost.com/p...o_survive.html