Little more than six months ago, after gathering strength for much of 2009, the euro reached a value of $1.51. That plateau came after a British newspaper reported that Middle East oil barons were secretly plotting to abandon the embattled dollar and set their prices using a basket of several currencies, including the euro.
Europe's coin — a decade after its celebrated launch — appeared finally to have come into its own.
No one thinks that today. Instead, amid a government debt crisis that has rattled Greece and taken aim at several of its neighbors, the euro — now worth $1.22 — seems blighted and adrift.
In recent weeks, prominent voices from German Chancellor Angela Merkel to former Federal Reserve Board chairman Paul Volcker have publicly wondered whether one or more countries might ditch the euro and resurrect their former currencies.
"Anything that goes beyond Greece will generate a systemic crisis of the euro area. ... This scenario opens up at least the theoretical possibility of a euro breakup. It could be the end of the euro itself," says Domenico Lombardi, an Italian economist and former member of the International Monetary Fund's executive board.
Lombardi, president of the Oxford Institute for Economic Policy, says such a eurozone fracture remains "extremely unlikely." Even as crisis waves lap at its shores, Europe is pushing to expand the 16-nation eurozone, not preside over its shrinkage. A European Parliament panel on Wednesday voted to approve Estonia for euro membership in 2011.
But what was once unthinkable has become fodder for market chatter, in large part because of the chronically tardy manner in which Europe's leaders have tackled the sovereign debt crisis. After weeks of delay and debate, the European Union, along with the International Monetary Fund, on May 9 unveiled a nearly $1 trillion financial backstop to prevent Greece or other heavily indebted eurozone countries from defaulting.
The ham-fisted official response has drawn new scrutiny to fundamental flaws in the euro project, exposing as exaggerated the single currency's hopes of rivaling the dollar as a global storehouse of value. "The euro's basically dead, for the time being, as a real reserve currency in competition with the dollar," said Daniel Gros, co-author of a book on the single currency and director of the Centre for European Policy Studies in Brussels.
In 2009's fourth quarter, 27% of the global foreign exchange reserves that the IMF could identify were held in euros, vs. 62% in dollars. The euro's share was up only slightly from the 26.2% in the fourth quarter of 2007.
Markets have calmed since announcement of the EU-IMF bailout, as the immediate prospect of a Greek default has receded. The yield on two-year Greek bonds has fallen from 18.2% on May 7, to 7.6% on Wednesday.
But today, the Carnegie Endowment for International Peace will issue a report that calls the euro crisis "the biggest risk to the global recovery at present."
A guarantee for peace
Most investors still expect Greece to eventually renegotiate its debt repayments, which could saddle German and French banks with massive losses. Weakened banks might then constrict credit flows to European companies, a major headwind for the recovering eurozone economy. But a Greek debt restructuring need not shatter the single currency.
"This could be done without leaving the euro," says Marino Valensise, chief investment officer for Baring Asset Management in London. "Leaving the euro would be very difficult technically, even more difficult politically."
Any country considering a euro exit would face enormous difficulties. Investors would shun any new drachma, lira or peso, seeing a new currency as certain to be devalued. Unless the ex-euro country repudiated all its existing obligations, it would confront a mountain of euro-denominated debt that would only grow bigger when translated into its new, weaker currency.
Rock-solid Germany, in theory, could abandon the euro and reintroduce the deutschmark. But the mark's attractiveness to investors would drive its value up, raising the prices of German exports on world markets and dealing a hammer blow to growth.
That's the economic argument for the eurozone holding together. But the political argument may be even more compelling.
The euro has always been as much about knitting together Europe's disparate nations as about tangible financial benefits. Introducing a common currency lowered transaction costs for businesses operating across European frontiers. It inaugurated an era of price stability and spread the benefits of low interest rates to poorer countries, providing them a needed jolt of financial adrenaline. And it helped spur development of the continent's corporate bond markets, providing European companies an alternative to traditionally dominant bank financing.
But as conceived by European statesmen after two devastating world wars, the single currency was a symbol of peaceful integration and development. Earlier this month, defending the EU rescue of Greece, former German chancellor Helmut Kohl, who was instrumental in the euro's creation, called the single currency "a guarantee for peace."
Europe's leaders, however much they chafe at the need to pay Greek bills, are loath to admit defeat in one of the continent's great endeavors. Likewise, the EU's debt-heavy economies regard euro membership as emblematic of their developed country status. Seeing it slip away would mark a great political humiliation, even as it would add real financial costs.
Attracting new members — beyond Estonia, whose annual GDP is about equal to Google's $23.6 billion annual revenue — might be more difficult. Smaller countries might look at Germany's grudging response to Greece's debt woes and wonder how much help they'd get in a pinch. Larger potential euro members that were able to weather the financial crisis because they retained their own currencies, such as Poland, also might hesitate.
"I don't foresee a eurozone breakup. ... But it's gone about as far as it's going to go," said Adam Posen, an economist at the Peterson Institute for International Economics in Washington.
The end?
Since Greek debt erupted into a market obsession in April, the euro has been sinking. Much of the currency's weakness can be attributed to structural flaws that have been part of the euro project from the beginning.
Chief among them: The 16 eurozone nations share a central bank with headquarters in Frankfurt. But while the European Central Bank acts like the Fed in setting one benchmark interest rate for both Dublin and Dusseldorf, there is no European treasury. Each nation is able to set its own levels of taxation and expenditure. It's a bit like driving a car with a state-of-the-art steering wheel, but no brake.
Since the debt crisis brought the issue into sharp relief, there have been calls for eurozone countries to better coordinate their fiscal policies. That could mean eurocrats in Brussels signaling "thumbs up" or "thumbs down" on budgets hatched in Madrid, Dublin, Athens or even Berlin. But European voters already are irked by the EU's so-called democratic deficit — the disconnect between an integrationist elite and their often more nationalistic publics.
"Among the masses, there is no appetite for further integration," Lombardi says.
Raghuram Rajan, author of Fault Lines: How Hidden Fractures Still Threaten The World Economy, anticipates closer coordination. But the former IMF chief economist says it likely will be limited to more central control of national budgets via an expanded monitoring framework.
Also weighing on the currency are longer-term worries about Europe's limited prospects for future growth. Last year, the European Commission said the EU's potential real growth rate would decline from 2.2% next year to just 1.5% in 2030. (By comparison, the Fed puts the U.S. long-term growth rate as high as 2.8%.) If the commission's gloomy prognosis is accurate, Europe is in for a long period of painful retrenchment. Growing its way out of its straitjacket of debt would be impossible.
"A lot of people speculate it's the end of Europe; it's the end of the euro. I just don't believe that," says Tim Adams, former under secretary of the Treasury for international affairs. "They'll find a way to muddle through. ... But the biggest challenge is how to generate growth."
Europe faces twin problems in this regard. A declining fertility rate and resistance to large-scale immigration are expected to limit the labor force and, thus, economic output. By 2050, Germany's population, for example, is expected to shrink on average each year, while the United States grows by 0.6% annually, Credit Suisse says.
The European Union in March laid out a new strategy designed to reinvigorate the continent's sluggish economy for faster post-crisis growth. Máire Geoghegan-Quinn, the EU commissioner for research and innovation, was in Washington earlier this week for meetings with U.S. officials about possible cooperative ventures. But along with boosting research spending and modernizing patent regulations, Geoghegan-Quinn says Europe needs a change of mind-set.
"We don't have a risk-taking culture in Europe. If somebody fails, it's like it's the death knell for the individual and the company," she told a European Institute luncheon.
Still, even as the investor consensus ravages the euro, it's worth remembering that the same herd instinct not long ago was pronouncing last rites for the dollar. Last year, as China's central bank chief called for a new global currency and Russian central bankers dumped greenbacks to buy euros, many saw the dollar's decline as inevitable. Now, the dollar is riding high, and the euro looks bedraggled.
"Views might change very quickly," Gros says.
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