15/12/2011 17:40 GMT | Updated 14/02/2012 05:12 GMT

A Turbulent Year for the Euro, But Could There be Worse to Come in 2012?

You could say that 2011 started well for the euro with the admission of Estonia on 1 January, bringing the number of members to 17. Confidence was high and EU ministers were optimistic that Ireland would be the final European country to ask for a bailout.

However, the reality was that Portugal was already under pressure in the bond markets. In April, Portugal succumbed to the inevitable and asked the EU and IMF for a bailout, which was approved in May with a loan of €78bn.

Greece, the first European nation to ask for help, found that the austerity measures imposed as a condition of their bailout were having a toxic effect on their economy, as unemployment rose rapidly and growth slid sharply. The IMF, ECB and EU insisted that Greece must impose further austerity measures before it got to the next tranche of its IMF loan, raising fears that the country will be forced to leave the eurozone.

In July the Greek parliament voted in favour of a fresh round of drastic austerity measures amidst a background of civil disorder and unrest from protestors having to bear fresh pain. In any event, the summit approved a new bailout of €110bn for Greece in addition to the original bailout plan.

At this point, the crisis started to spread to the bigger economies of Spain and Italy. Yields on Spanish and Italian bonds began to rise as investors trimmed down their holdings of European government bonds and moved them into safer German, Dutch and even UK government bonds. As a result, pressure was brought to bear on Italy and Spain to assure the markets that their finances were under control. Italy finally passed a €50bn austerity budget in August after weeks of haggling in parliament in the face of fierce public and political opposition, with the result that several measures were watered down.

Europe was beginning to spin out of control and anxiety started to build across the globe with US Treasury secretary Tim Geithner urging European leaders to get to grips with the crisis. With the IMF, OECD and the EU starting to downgrade growth forecasts for Europe, markets started to come to the conclusion that EU leaders were running out of ideas as to how to deal with the crisis.

Matters eventually came to a head in Greece and Italy with the replacement of both elected Prime Ministers, with Lucas Papademos in Greece and Mario Monti in Italy. Both leaders tightened the screw even further under pressure from German leader Angela Merkel, who insisted that their economies needed structural reform against a backdrop of civil unrest and rioting.

Summit after summit came and went during October and November each accompanied by dramatic headlines such as "6 weeks to save the euro" and later "5 days to save the euro". These headlines culminated in the EU summit on 9 December which resulted in the controversial fiscal compact from Angela Merkel and Nicolas Sarkozy, ultimately vetoed by David Cameron and the UK.

Changes proposed by the compact included an agreement to stick to the budgetary disciplines of the original Maastricht treaty which stipulated that deficits should not exceed 3% of GDP and that debt to GDP ratios should not exceed 60% of GDP, with penalties for non-compliance.

Despite the compact, most EU members are already in breach of the Maastricht criteria. In order to get in line, spending cuts and tax rises will have to be implemented, which will impinge growth even further at a time when growth is already stalling.

Much has been written about the wisdom of David Cameron's actions with a lot of his critics suggesting that he has thrown the baby out with the bath water. However, given the obstinacy of Merkel and Sarkozy in driving the new fiscal compact with forensic scrutiny of national budgets, one can't help thinking that the euro is heading full tilt towards the buffers.

If this is the case, the UK may find that it is not as isolated as it once was, especially if the austerity espoused by Merkel drives taxpayers to revolt and governments to fall, as has already been the case in over four European countries this year.

Ultimately, the European banking system is fundamentally insolvent, as are some governments, and with cracks already starting to appear it can only be a matter of time before the fault lines start to turn into chasms in the face of zero growth.

The bottom line is that for the euro to survive it needs to go for full blown fiscal union, or break up, it's as binary as that. Given the political and legal obstacles in its way, the current odds are on it breaking up.