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The Rupp Report: The Euro Under Pressure

Jürg Rupp, Executive Editor

The eurozone is experiencing the heaviest endurance test in its 11-year history. Its structural weaknesses, which critics had pointed out from the beginning, are now appearing: Some analysts already predict the collapse of the eurozone.

While the European Central Bank is operating a uniform monetary policy for the eurozone, the financial policy is still an issue for the individual member countries. The temptation lurks not be too disciplined with the budget, knowing that the costs occurring in the form of a lower stability and higher interest rates for the eurozone are carried by all members. The creators of the euro wanted to counteract this situation by establishing a stability and growth pact that commits the members to executing a cautious financial policy. Over the years, however, this contract has been watered down increasingly by all eurozone countries.

The EMU As A Savior
The eurozone effectively has a two-class society: The structurally weak south with its deficit contrasts with the competitive, strong and stability-oriented countries in the north. This contrast has become not smaller, but greater, with the establishment of the European Monetary Union (EMU) and its too-strong orientation toward a fiscal convergence of the members. On one hand, the southern Europeans have lost competitive strength because wages there have increased more strongly than the productivity of their economies. On the other hand, Germany in particular is not ready to correct its strong export position and boost domestic consumption.

These structural breaks within the eurozone remained largely overlooked during the economic upswing from 2003 to 2007. Also, after the start of the financial crisis, the EMU showed itself to be stable. It saved Europe, namely the south, from turbulences that would have been intense without a single currency.

Greece As A Touchstone
This situation changed when the over-indebtedness problem of the southern European states came into focus in the developed world, and even the prospect of a national bankruptcy was not excluded any more -- as can be seen in problems with Dubai. Soon, Greece became one of the weakest candidates -- a country that over the years has spent more that it has and hasn't hesitated to manipulate its economic statistics. The shock followed the election last October, when the new Greek government had to admit that the state deficit for 2009 would amount to 12.7 percent instead of 6 percent of the gross domestic product (GDP).

Because Greece has accumulated debts even in economically good times, the country has succeeded in joining the eurozone only thanks to faked statistics. It suffers from a weak economic situation, but also generally from fragile economic structures and scant political reliability.

Greece must take on about 60 billion euros of debt in 2010 -- of this, about 40 billion euros in the first half of the year to cover the monetary requirements. Already, the Greek state pays around twice as much interest as Germany, and the more dangerous its financial position for its loans becomes, the larger the debt service levy grows. Basically, Greece's significance for the eurozone is said to be irrelevant, as its GDP share is 2.5 percent. But the problem for Europe is that if Greece goes bankrupt, the whole southern region will be threatened. Large investors, such as hedge funds, already are betting on this scenario.

No Devaluation Of The Euro
According to European Union (EU) rules, the budget deficit must not exceed 3 percent measured against the national GDP, and total indebtedness shouldn't be higher than 60 percent. However, Greece's total indebtedness amounted to some 115 percent in 2009. Although Greece is not the only country that has such problems, there is no other country in which the situation is that serious.

The classic way out, a currency devaluation, is not open to Greece because of its eurozone membership. In spite of all disclaimers, if countries like Germany or France should help by providing billions of euros, they will be considered to be potential rescuers if any problem occurs. This would lead to a heavy disintegration of confidence in the euro because every country will know that if it has problems, Germany and France will help in the end, and every country can go into debt at the other countries' expenses.

Various analysts, mainly from the United States, already are envisioning a market-driven exit of some countries from the EMU or even the complete collapse of the eurozone. But the Europeans, looking back at historical experiences, have the political will to prevent a failure at all cost. A breakup of the EMU would be close to a failure. That's why the 16 countries of the eurozone are working hard to prevent this unthinkable situation.

Greece has become a risk for the euro and the entire EU. Greece's national debt has pushed the value of the euro down and boosted speculation in recent weeks that the eurozone could break down. The European Commission has already taken measures to take a hard line against Greece. The worries over Greece already threaten to jump over to other eurozone states that have very high indebtedness. The next weeks and months will show how Europe can get out of this tight spot and handle the problem.

March 2, 2010