The past few weeks, Europe and the Euro have again been much in the news. Europe has never experienced a real “rough patch,” or serious monetary crisis like the one it is facing now.

Even while it seems there are a great many doomsayers these days, posterity will remember Germany's aggressive support of the euro, and Chancellor Angela Merkel's raucous demands that all of the EU's sovereigns come to salvage its ailing members, for the good of the Continent. With their hats in hand, the countries of EU commonly known as the PIIGS group (Portugal, Ireland, Italy, Greece and Spain), have had to come to the European Central Bank (ECB).

It is Germany alone that used its muscle power to influence other states to join its salvage efforts. And, it is clearly evident from the events of the past weeks that it is Germany's unstinting, magnanimous financial support that lubricates the interconnected gears on which the entire European system turns.

Without the timely initiative and intervention of Germany, European sovereign debt would have sunk the EU, as well as the global markets. Today, Europe is committed to filling the Greek financing gap for as long as the Greek government sticks to its austere budget consolidation programme. After the rollover of private debt, the majority of the Greek government's remaining debt will be taken care of.

The same is the case for Ireland and Portugal. As long as these two countries follow the statutes of their budget programmes, they will be able to refinance their debt as it falls due, at low interest rates from the European Financial Stability Facility (EFSF).

Be Wary of Italy and Spain

Greece, Ireland and Portugal will most likely not bring down the European financial system. But a default or restructuring of their debt will be unpleasant for European banks.What the world needs to watch out for is Spain and Italy. These are much larger economies and the exposure to their debt is much larger. A crisis in these two countries will make the current difficulties look like a cakewalk. While there is hectic activity among leaders of the more affluent Euro zone countries such as France and Germany, citizens of these nations are dead-beat exhausted with the idea of bailing out their more squandering, spendthrift compatriots.

On the other hand, citizens of weaker countries are angry that monetary policy has been outsourced to Berlin and Brussels and their governments are being forced to adopt harsh austerity measures.

Even more menacing, there is no mechanism in place for any of these weaker countries to storm out of the Euro zone, right away.

Indeed, rightly so, as it would be catastrophic if Greece, for instance, drops out now. Its debts would have to be redenominated in a new currency, interest rates may rise sky high, deficits may worsen and economic growth could crumble. And, since European banks own huge amounts of Greek debt, the turmoil would only spread.

So, for the moment, laggards like Greece will need to hang about and discipline themselves.

Euro in Four Years

Looking back, there was a time, not long ago, when people saw the euro as the ‘knight in shining armour' currency of the planet that would replace the dollar as the world's reserve currency. But now, it seems, the planets are not aligned for the euro to step up to the plate and become the world's reserve currency. Not as yet, at least.

Yes, it is a fact that the euro can only be as strapping as these weakest links. Regrettably, none of these weak links are in good health yet. More importantly, they are not going to recover anytime soon.

However, I still strongly hold my view that ‘Europe and Euro are Immortal' (refer my column in Business Line of May 17, 2010). I am of the firm opinion that there is not an iota of a chance of a break up of the EU.

But I very much doubt if Euro zone will keep all its members.

It seems very likely to me that Europe will have to flush out the albatross that is dragging it down — sooner than later. In fact, this is the worst-case scenario that has been tossed about ever since Europe's debt problems emerged. The larger countries like Germany and France will still be in the euro zone. The other large economies — by GDP — such as Italy and Spain will somehow find a way to remain in the Euro zone.

But the smaller economies that are a-fifth the size of these larger ones will be forced to exit the euro and establish their respective home currencies. For instance, even if Greece may not be going down to a Trojan-level rout in the next few days, or even weeks, there is little doubt that the country cannot afford to remain strapped up to the euro. With these smaller countries having their own currencies and central banks, they will be able to simply undervalue their currency when debts heap up.

It is not the best solution, but it will help as these smaller countries will no longer haul down the larger economies. In the end, it will work out best for the Euro zone.

(The author is a former Europe Director, CII, and lives in Cologne.)

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