Hamish McRae: A future without the euro is a distinct possibility

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Fears about the future of the euro have helped plunge global markets into chaos, with share prices around the world reacting to the possibility that the eurozone will break up and that several of its member countries may default on their debts.

Will the euro survive? It is a question that, two years ago, would have seemed outrageous. Anyone who suggested that the eurozone was fatally flawed was branded as a Europhobe, someone who hated the European Union, not just its single currency. For the euro appeared a success. After a few wobbles, it had established itself as a major currency, while across the Continent, euros were making it easy for people to travel and trade. More important, adopting the euro seemed to have given a greater stability to countries that had previously had weaker currencies, such as Italy and Spain, cutting their interest rates and encouraging growth.

True, there were rumbles of discontent. Many in Germany felt the country had had to adopt too tough a policy to hold down its costs, whereas in Spain and Ireland the soaring property prices exposed the difficulties created by one-size-fits-all interest rates. Even more ominously, a number of countries, including France and Germany, had breached the rule in the Maastricht Treaty that fiscal deficits should not exceed 3 per cent of GDP. But while the boom continued, these problems seemed a small price for the stability it gave the Continent.

The global recession changed everything, exposing three grave structural problems within the European economy. One was that the countries that had enjoyed the greatest booms, thanks to soaring property prices, also experienced the greatest busts. It would, with hindsight, have been better had both Ireland and Spain been able to lean harder against their booms by increasing interest rates. A second was that Germany was forced to restrict demand rather than help growth by buying other countries' goods. And most seriously, the governments of some of the weaker countries were able to run large deficits, financed by cheap euro borrowing. The burst of growth they experienced concealed their lack of fiscal discipline.

The trigger for the current mayhem was the inability of the Greek government to service its debts without support. But the massive credits mobilised two weeks ago to support Greece and other weak eurozone countries, totalling almost €750bn ($1 trillion), have failed to convince the markets that Greece can repay its debts. Further statements by eurozone leaders, including a threat by President Sarkozy of France to pull out of the euro altogether if Germany did not sign up to further guarantees of other countries' debts, made the markets wonder whether the euro could be saved.

But this is a problem that goes far beyond Europe. It took a call from President Obama to push Chancellor Merkel to support the latest package, and there are meetings next week involving Tim Geithner, the US Treasury Secretary, as well as the leading eurozone finance ministers, which will attempt to restore calm. As for the eurozone itself, Germany is pushing for a new and tougher version of the Maastricht Treaty to limit the ability of the different governments to run deficits. Meanwhile, fears that a eurozone country could default are threatening the entire economic recovery, for a default would put huge strains on banks that hold eurozone debt. Greece has become the new Lehman Brothers: a potential collapse that would undermine the global banking system.

Will market calm be restored? The answer is surely yes. Eventually, governments and central banks, working together, always win. One of the reasons for the present mayhem is that there are evident sharp divisions between the main eurozone countries. The European Central Bank has lost trust, too, by apparently taking on the debt of the weak countries when the markets would not.

Will the eurozone survive? That is harder to call. But it is now clear that survival will require either that it becomes in effect a fiscal as well as a monetary union, with much tougher controls over the budgets of the members – or that some countries are forced to drop the euro, at least for a while. Once it is apparent that, say, a Greek or Spanish euro is not as secure as a German euro, then the monetary union cannot survive.

These strains will get worse as much of southern Europe struggles with austerity. It is true that there is huge political will to make the eurozone survive. That may enable it to scramble through this economic cycle. But even its supporters question its longer-term future. Even if the currency survives this recession, it will not survive the next one.