ECJ EUROPEAN Cleaning Journal

Europe's single currency has entered its 10th anniversary year under increasing pressure from the markets and with its very survival in doubt. Hartley Milner looks at the events that brought the euro to the brink in 2011 and those that could tip it over the edge in 2012.

Oh dear, the outlook for the embattled euro is not looking at all bright, is it? While not on its deathbed just yet, the prevailing view seems to be that attempts to halt the currency’s decline have so far amounted to little more than a field dressing on a very deep and possibly fatal wound.

After the bailouts of the previous 12 months, 2011 was widely expected to be a year of stabilisation and recovery for the euro, signalling new hope for the wider European region and the global economy.

However it soon became clear the depth of the crisis had been woefully underestimated, and rather than showing signs of returning to health the eurozone ended the year fighting for its life. So where has this sorry saga of runaway sovereign debt, fiscal austerity and market turmoil landed us in early 2012?

Last year, in addition to Greece, we saw Portugal and Ireland receiving bailouts, a beefing up of the eurozone rescue fund, heads of state swept out of office and finance ministers meeting at the euro’s ‘last chance saloon’, but emerging with only stop-gap solutions. As the euro limped along polls showed the real victims in all this, the region’s voters, were increasingly becoming disillusioned with their leaders’ management of the crisis and the austerity imposed on them, sparking street protests against the unacceptable face of capitalism last year.

The New Year saw EU officials continuing their efforts to stabilise the currency, with eurozone countries needing to refinance up to 650 billion euros of debt by the end of April. After the troubles in Greece, Portugal and Ireland, Spain announced its budget deficit for 2011 would reach eight per cent of its gross domestic product, two per cent higher than its previous estimate – raising fears it could be the next to need help.

As part of its new 130 billion bailout, Greece has been negotiating with its creditors for them to accept a nominal 50 per cent cut in the value of their Greek bond holdings. In March Athens is due to make a 14.4 billion euro bond repayment or risk becoming the first eurozone country to default on its debts, currently at 350 billion euros.

Also last month, we saw credit agency Standard & Poor's downgrade nine eurozone countries, including stripping France and Austria of their coveted triple-A status and consigning Portugal to junk status. Worryingly, highly indebted Italy found itself on the same BBB+ level as Kazakhstan, further heightening the prospect of the country succumbing to its 1.9 trillion euro debt burden. As the third largest eurozone economy, it is considered too expensive to bail out.

Crunch year

Certainly 2012 is likely to be a crunch year for finding a resolution to the euro region’s ills according to Professor John Ryan of the Centre for International Studies at the London School of Economics, and he has not been at all impressed by efforts made to tackle the crisis so far.

“I believe at the moment there is a strong enough political will to keep the show on the road,” he said. “But the decision making that is going on at the top level of the European government is not very inspiring. And you can only make so many mistakes before you get to the point where your position might get to be untenable. But as it stands, there is a lot of political will to make the euro work.

“The country that is particularly important in all this is Germany. The euro is a very good vehicle for its export performance, and if Germany had to revert back to having its own currency, the Deutsche mark, it would be a very strong currency, up there with the Swiss frank. Germany has a very strong export machine that competes at world level with China. So if Germany had a strong Deutsche mark, that would severely limit its capabilities as an exporter. It is in its interests to get a solution to this, because while it is wrapped up with a lot of weaker countries in a weaker euro its exporters can do quite well.”

At the time of going to press, Prof Ryan was predicting that Greece would get a write-down of what it owes, in return for better managing its debt and bringing in a range of effective austerity measures. But it was likely to be at a much lower rate than the 50 per cent being negotiated at present, possibly more than half that figure.

Defaults likely

But Prof Ryan warned that whatever the write-down agreed, it would probably not be enough and the only effective alternative to debt restructuring would then be for Greece to undergo a 'proper default' with bondholders, mainly the banks, taking the hit. As for Greece leaving the eurozone, he said this is not an option the country wants, even if there was a constitutional mechanism to allow that to happen.

“Then Ireland or Portugal will need to restructure their debt,” he said. “If we go into a downturn in 2012, you will see Ireland and Portugal run into serious problems, and so after Greece we will be looking at these two countries, possibly with a view to their defaulting, but certainly significantly restructuring their debt.

“After that, we will need to look at what’s happening in Spain and Italy and whether we need to do some firefighting there – and we will almost certainly have to do so – and that leaves us with the United Kingdom and France having some problems for various reasons. You’ve been hearing that France is having difficulties with its exposure to Greece, well its exposure to Ireland is probably as bad as it is to Greece, and I think France’s exposure to Italian debt is about half a trillion. So it could be a very tricky time in deed for France.” He said the UK was vulnerable because of its exposure to Ireland and dependency on financial services.

Prof Ryan stressed that as well as its internal troubles the eurozone was vulnerable to economic influences beyond both its borders and its control, with one particular threat looming from the east.

“There is quite a lot of evidence coming out of China that the economy is starting to falter, that its export machine might be starting to slow down,” he said. “This is almost obvious really; when you think the two biggest export locations for China are the eurozone and the EU. China looks like it is going to have a problem, and we know the United States has been in trouble for a while. So the outlook for 2012 is not looking very good at all.”

Euro 'will survive'

But he added cautiously: “If we can somehow sort out the eurozone’s troubles and the US debt crisis, I think the global environment would be a much better place and we would all feel much more confident about moving forward.”

Last month, the International Monetary Fund’s (IMF) financial counsellor, José Viñals, warned that global financial stability risks had increased substantially, reversing some of the progress made over the previous three years. He said banks have had to withstand an increase in credit risk coming from high-spread euro area sovereigns estimated at about 200 billion euro. “If we include exposures to banks in high-spread euro area countries, the total estimated spillover increases to 300 billion euros,” he added.

“At this time, where sovereign risk is very important, what we have is a two-handed approach. First, you have to deal with the source of sovereign risk at its heart. That means pursuing credible medium-term fiscal consolidation policies that will reduce the source of sovereign risk, and that will do a lot to relieve the pressure on banks.

“But because this is something which is likely to take time and markets may not be convinced overnight, you need to have a complementary approach, which is to make sure that all banks in the European Union have adequate capital buffers.”

However, the euro’s collapse is not on the agenda for Christine Lagarde, managing director of the IMF. "Will 2012 be the end of the euro currency? I seriously don't think so,” she said recently. “It’s a young currency, it’s a solid one as well."

Lagarde went on: "You have within the zone, not in relation to the currency, serious pressure and issues concerning the sovereign debt, concerning the strength of the banking system which are being addressed.

“But the currency is not one that would vanish or disappear in 2012, not at all."