1. "Life support" for the Euro
Throughout this summer, the Eurozone has been navigating in stormy waters, with only remote hope that the volatility of financial markets might calm down in the Autumn. According to ECB President Jean-Claude Trichet, the European debt crisis held the potential for the worst market collapse for almost a century. Increasingly, economic observers speculate on the Eurozone's survival and question whether European integration itself would survive a collapse of the Euro.
Is the European currency 'under life-support', as some euro-sceptics argue, not without Schadenfreude {malicious enjoyment of someone else's misfortune} - and forgetting the actual state of their own home economy and the collateral damage that a collapse of the Euro would cause far beyond Eurozone boundaries? Is it just 'an idea that cannot work'? What is needed to make it work?
2. European Union is both monetary and economic
Over the last 12 years, monetary union has been an undeniable success. However, several Eurozone members have overlooked the fact that the Economic and Monetary Union (EMU) was not only designed as a monetary union, but also as an economic one. Lack of economic and fiscal convergence, hence insufficient progress towards an optimum currency area (Mundell) along with an absence of political union to back up the whole project, means that the Euro area has not been able to achieve more homogeneity and is not sustainable in its current form.
These systemic weaknesses inherent to EMU foundations have now been uncovered by the difficulties in the financial sector - even though these were generated outside Europe, and worsened more recently due to increasing concern about sovereign debts. Fiscal rules were too weak to prevent some Eurozone members from running unsustainable deficits that sparked several crises.
3. Europe's fractured North-South divide
As a result, the Eurozone increasingly appears to be fractured between a 'northern' group (consisting of Germany, the Benelux countries, Austria, Estonia, Finland, Slovakia and Slovenia), and a 'southern' group (comprising Greece, Ireland, Portugal, Spain and Italy). France finds itself on the edge of this North-South divide but bends dangerously towards the southern group. The northern group has a strong industrial specialisation, controls its production costs, has a trade surplus and balanced public finances and fairly high potential growth. The South provides non-exportable services, has uncompetitive production costs, suffers from macroeconomic imbalance, and faces increasing hurdles in servicing its debt.
4. The only solution for Europe
Will this widening North-South divide between fiscally prudent, triple-A rated countries in the North, and increasingly struggling debtor nations in the South, lead to an implosion of the Eurozone? Consequences would potentially be disastrous, both for global economic growth (the EU has the largest GDP and is the main trading area in the world), and for the European project as a whole.
Most economists and policy advisers agree on what needs doing: Europe can only resolve this crisis by means of creating Eurobonds and implementing a fiscal union, that is, by mutualising national debts. The ECB can continue to expand sovereign bond purchases (and, de facto, make of its liabilities a hidden Eurobond) and it can also cut interest rates. But this will only save time whilst political leaders are postponing the inevitable Europeanisation of sovereign debts. More than an economic choice, the dilemma they are facing is a political choice.