Why the eurozone will survive

by Martin Wolf

Financial Times
March 8, 2011

On December 16 2010, European heads of government solemnly declared that they were “ready to do whatever is required” to protect the eurozone. Words are cheap. Sceptics may wonder whether to take them seriously. In this case, they should. The eurozone is highly likely to survive, albeit not without further turbulence. I would advance three arguments: first, the eurozone is backed by a profound political commitment; second, the long-term interests of participating countries are behind it; and, finally, the members can afford it. In short, the eurozone has the will and the wherewithal to keep the euro experiment afloat.

An interesting new report: “Europe will work”, published by Nomura Global Economics under the direction of John Llewellyn and Peter Westaway makes the case. As it reminds readers, the eurozone is the product of a process of European integration that began in the aftermath of the second world war. Even for today’s leaders, this remains an existential project, even though the memories of the war have faded in their populations. Moreover, the premise that economic integration would create powerful interests for its perpetuation has also proved correct. Finally, the consequences of even a partial break- up of the eurozone are unknowable and frightening. Only in extreme circumstances would European leaders contemplate this step.

Thus, while many Germans are angry over the sloppy behaviour of certain partners, the country’s elite remains aware of both the perils of isolation and the benefits of the stability that the European project has brought to their country in its relations with all its neighbours. Similarly, the leaders of the countries now in difficulty fear the outcast status that would follow exit from the eurozone. This does not mean that some form of break-up is inconceivable: Germany would exit if the body politic concluded that membership was incompatible with monetary stability; peripheral countries would also exit if they concluded that membership was incompatible with prosperity. Neither is close to that decision, as yet. Debt restructurings are quite likely, any sort of break-up much less so.

Paradoxically, the tragedy of the eurozone is that it worked too well. The convergence of perceived risks stimulated accelerated convergence of incomes. In the euphoria of the time, incautious lenders lent borrowers the rope with which the latter could hang themselves, be they irresponsible governments (as in Greece) or foolish private entities (as in Ireland and Spain). The result was huge indebtedness. (See charts.)


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