Crisis Renews Concerns on Euro - WSJ

Crisis Renews Concerns on Euro - WSJ


FRANKFURT—The worsening debt crunch on the euro zone's periphery has reawakened concerns about the viability of a currency union that encompasses 16 sovereign nations with disparate economies.

When the euro was introduced in 1999, supporters argued that strict controls on member states' deficits would, over time, compel weaker members to become more competitive. Instead, the lower interest rates that came with membership have allowed countries such as Greece and Portugal to take advantage of cheap borrowing costs to spur domestic growth, papering over their structural inefficiencies such as low productivity and high labor costs.

The looming financial crisis has laid these problems bare, making it increasingly difficult for the weaker countries, including Portugal, Ireland, Greece and Spain, to both revive their economies and service their debts.
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That is in part because the more governments have to pay in interest on their outstanding debt, the less they can absorb infrastructure spending or tax cuts that could improve the underlying potential of their economies. That, in turn, is undermining confidence in the euro itself as investors have begun to worry that Europe's monetary union could unravel.

The euro, which Thursday fell to a eight-month low of $1.3741, is still quite high by historical standards. It traded at around 85 U.S. cents a decade ago when many investors questioned its viability.

What worries some observers more than the decline itself is the fall's velocity. The euro has lost about 9% against the dollar since December. One concern is that a further drop could make it harder for countries with high current-account deficits, such as Greece, to attract the foreign capital needed to finance them.

By most accounts, the worst-case scenario—a breakup of the euro zone—remains very remote. Nevertheless, the debt problems in Greece and other periphery countries highlights Europe's lack of a powerful political framework. The European Central Bank sets interest across the 16-member euro zone but has no direct power over members states' fiscal policies.

The euro zone "has one central bank, but there isn't political union," says Meg Browne, a currency strategist at Brown Brothers Harriman.

That is making it difficult for the EU to overcome the current situation by taking direct control of the budgets in troubled member countries.

Meanwhile, a weak economic outlook and very low inflation have raised doubts about whether Greece, Spain and others can cut deficits enough even if they make all the right political choices. Those countries enjoyed a mix of strong economic growth and moderate inflation that filled government coffers from 2000 to 2007, allowing them to maintain levels of government spending that proved unsustainable.

Now, the reverse is happening. Government coffers are drying up. The economic reforms that European officials say those countries need to become more competitive imply sluggish growth and perhaps even deflation in the years to come, making it still harder for governments to generate revenue.

Whether the common currency withstands this latest threat depends greatly on Spain. The most vulnerable peripheral countries—Portugal, Ireland and Greece—combine for only 6% of euro-zone GDP. When Spain is added to the mix that share rises to almost 20%. Though often lumped into the smaller periphery, it has one foot in the core group of Germany, France and Italy.

Many economists believe the only way to fend off the crisis is for the periphery countries to undertake drastic budget cuts in the face of what is likely to be fierce public opposition. Such steps could help dispel concerns about the cohesion of monetary union and strengthen the euro.

Write to Brian Blackstone at brian.blackstone@dowjones.com