The words that have dominated headlines on the euro have bordered on apocalyptic: crisis, blowout, sinking, disaster, chaos, death, storm, tragedy, fear, contagion. This is how the world has come to see Europe's shared currency.
Anyone reading about the euro from the time that Greece began to unravel in January would have assumed that the greatest economic experiment since the end of the Second World War, perhaps since Roman troops employed pointy objects to unify Europe 2,000 years ago, was a dud, kaput, finito, mort. The North American media and the economists they quoted were particularly down on the 11-year-old euro project. They endlessly referred to American economist Milton Friedman's prediction that the euro would not survive Europe's first big economic crisis.
Mr. Friedman's skepticism about the euro's long-term viability may yet prove well founded. But on the eve of the Group of 20 summit in Toronto, the leaders of the euro zone countries will not arrive defeated, their heads bowed. That's because, already, there are signs the worst is over.
Some of Europe's most prominent economists are betting that the euro, bruised and bloodied as it is, will live to fight another day. "We believe that the euro zone will survive this current crisis," a team of six Deutsche Bank economists and strategists, led by David Folkerts-Landau, said in a June 18 report.
To be sure, the European Union in general and the 16-country euro zone in particular still have enormous problems, they said, and face years of weak economic growth. The overall picture, however, is not as bad as it seems and looks positively rosy compared with - get this - the world's biggest and most flexible economy. "The euro area in aggregate has a stronger financial position than the United States," the report said.
Marco Annunziata, chief economist in London for UniCredit Group, Italy's second-largest bank, more or less agrees that the EU has pulled back from the brink of potential destruction. "In a nutshell, it seems to me a number of EU policy makers now realize the need for fiscal and structural reform," he said. "For the first time in many years, since politicians have their backs to the wall, there is reason to hope they might surprise us on the positive side."
Compare the tentative optimism with the black mood in April, when the EU debt crisis was in full swing and investors were gripped with something close to panic. By that month, it was apparent that Greece - with a 2009 deficit equivalent to 13.6 per cent of gross domestic product and a contracting and massively uncompetitive economy - could not make it on its own. As its finances deteriorated, Greek bond prices plunged, sending yields, and hence borrowing costs, in the opposite direction. Two other debt-swamped countries, Portugal and Spain, were also close to financial ruin as bond investors steered clear.
The big fear was a second banking crisis, one that would be triggered by sovereign debt defaults. More than 70 per cent, or €210-billion ($270-billion), of Greek government debt is held by foreign banks and other investors, such as pension funds.
In the first week of May, the benchmark Euro Stoxx 50 index lost 10 per cent and Greek "default" tripped from the lips of investors and economists. Finally, after months of dithering by Germany, the EU's paymaster, the EU finance ministers finally got serious about an emergency rescue. On May 10, the ministers announced a rescue package valued at €750-billion. The figure was far bigger than expected and was designed to cover the financing needs of Greece, Portugal and Spain if all three debt cripples were to default.
Why did Germany approve the bailout? It wasn't about saving Greece, a country many Germans hold in contempt. It was about saving the euro.
The goal, of course, is to avoid draining the rescue package. To that end, the EU countries with the most strained finances - Greece, Portugal, Spain, Italy, Britain, Ireland - have been rolling out tough austerity programs. So has relatively healthy Germany. France is expected to be next. By slashing public spending, raising taxes, lifting retirement ages and making labour markets more flexible, the EU countries expect to reduce their deficits to 3 per cent of GDP or less within few years.
There are no assurances that the austerity programs will work, especially since economic growth is weak and rising social unrest may sap the political will to see the programs through in some countries. The austerity efforts could even backfire if they push the EU back into recession, or trigger deflation. Still, the falling bond yields and bond default insurance costs suggest the immediate crisis has abated. The euro's freefall has stopped and the currency's lower value will boost exports and help bring down current account deficits.
At the G20 summit, the EU leaders will be asked to give an analysis of their progress in fixing the debt crisis. They will be able to say that a lot has changed for the better since the spring. If they're in a fighting mood, they will tell the Americans that the United States, with a deficit of 10.2 per cent of GDP compared with the euro zone's overall 6.1 per cent, is the next disaster in the making. But such rude talk has no place at a diplomatic gathering.
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