Euro Q&A: How did it come to this – and what happens next?

(JOHN BRADLEY)

Q: Why is the euro threatened?

A: Because it is still politically feasible for members of the single currency to drop out of it – especially if exiting is a less painful solution to their problems. Or the only possible solution. No one could foresee South Wales or West Virginia opting out of the pound or the dollar, even if having their own money might help them sell their products outside their "borders".

Q: So why don't the Greeks, the Irish and others just leave the euro now?

A: It is not a painless solution. If they adopt a "new drachma" or "new punt" their overseas debts, many denominated in euros, will automatically be revalued upwards, making them even more difficult to pay off. People's savings would be devalued and devastated. In those circumstances a national default would become a reality in Europe, something hitherto confined to Africa, Latin America and Russia. It would be humiliating, make borrowing very expensive, and might be even worse than defaulting within the euro.

Q: Why is that option not mentioned?

A: Because it would suggest any member state could run up unsupportable debts without restraint, and would thus drive down the integrity and value of the euro for its existing members. Borrowing costs throughout the zone would probably rise, and a domino effect (see below) would leave virtually every nation vulnerable to further market attacks, once the precedent had been set. Still, it might be a least-worst option.

Q: What is "contagion"?

A: Mainly precedent; once one nation has been bailed out, the hunt is on for "who's next?" Hence the domino effect. Europe's banks are closely related, operating across borders – think of the Spanish Banco Santander's ownership of Alliance & Leicester, Bradford & Bingley and Abbey in the UK, or the Royal Bank of Scotland's Ulster Bank subsidiary lending in Ireland. They all lend to each other, so if one set of banks encounters trouble it spreads. EU member states are usually each others' largest trading and investment partners; if one suffers they all do.

Q: Any other threats?

A: The Germans. So far their commitment to the European project has outweighed their devotion to sound money, low inflation and fiscal rectitude. However, if their "loans" to Ireland, Greece and the others may turn out to be "gifts", they could be faced with a tough choice. When the euro was launched the Germans were reassured by the "Maastricht Criteria", enshrined in Treaty form, that limited national borrowings and debt levels. Such constraints are now trashed. Besides, Germany's pockets are not bottomless.

Q: Haven't we forgotten somebody?

A: Yes, Jean-Claude Trichet, president of the European Central Bank. He has been keeping the Irish, Spanish and Portuguese banks alive for months by lending them cheap money ("liquidity"). The ECB has also bought Irish government bonds. Mr Trichet made little secret of his desire to bring this artificial system to an end. Even if he wanted it to go on, it couldn't: the euro would be sold off massively if the central bank tried to print trillions of euros to pay off bank and national debts. Knowledge of the ECB's desire to switch off the life support system didn't help the Irish banks' chances of survival.

Q: Can't the bailout fund pay for all the problems?

A: No. large as it is, most observers say that Spain's difficulties would probably overwhelm the €750bn European Financial Stabilisation Fund, and Italy would certainly be far too big to save. The EFSF is becoming stretched. After the Greek crisis earlier this year it was set up to be a "shock and awe" deterrent that, like nuclear weaponry, was so terrifying to the markets that it would never be used. As we see, the market is capable of outgunning even those potent munitions. In this case the IMF would have to stump up funding, and it would be taken out of the hands of the eurozone. Thus even the EU itself could lose its sovereignty to a body underwritten by the US. The French would find that fate unacceptable.

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THE DOMINO EFFECT

Successive financial crises have revealed the markets’ cruel habit of treating companies, banks and nations as dominos waiting to fall. In the credit crunch of 2008-09 it was the British banks that fell successively; later it was the Wall Street investment banks. Now it is the turn of the sovereign states that use the euro, many of which have adopted their banks’ debts. The record is not good...

GREECE

Long the weakest link. Greece’s profligacy and inability to collect income tax caught up with it, and the rest of the EU, in May. Given a €110bn bailout after protesters stormed the parliament. It may not be the last rescue it needs. Greece so scared EU leaders they set up a €750bn bailout fund.

IRELAND

Unlike Greece, Ireland has a fairly competitive economy, though it was harmed by a decade-long party funded by debt at low German rates of interest. The property collapse and insane banking activity did for the state. Successive austerity packages just seem to make matters worse. Bailout estimated at €80bn to €90bn.

PORTUGAL

Pretty much written off already. More like Greece than Ireland; though all three nations rely on the European Central Bank to keep their banks afloat Portugal’s system is less in chaos than Ireland’s. Its problem is keeping up with German productivity levels without the option to devalue. Another €100bn?

SPAIN

In some ways the the biggest worry, though not the most likely to implode. Empty and half-built apartment blocks and villas on the costas are a visible testament to a decade of excess. High unemployment is also an issue. Public finances about as bad as the UK’s, but Spain's highly devolved system of government may harm attempts to correct them. Small banks, the cajas, are very weak. €420bn?

BELGIUM

Like Spain, a nation with many separatist stresses within even before the crisis began. Has a surprisingly long record of fiscal delinquency. Debt to GDP ratio of 100 per cent is high and possibly unmanageable. Crucially, lacks a proper government to implement any austerity budgets.

ITALY

Escaped relatively well so far, given its past record of economic and fiscal mismanagement. Still, it faces the usual southern European problems of competitiveness and an ageing population. Public finances and banking system healthier than many peers. Far too big to save.

THE EURO

Born in 1999. The first decade of its life was relatively happy. Now the currency seems no more durable than the Exchange Rate Mechanism or the various pegs, “crawling snakes” and other currency links tried previously. Without the euro there is no European Union, say European President Herman Van Rumpuy and German Chancellor Angela Merkel.