Eurozone Collapse: Were Predictions Misguided or Premature?

The eurozone is undoubtedly in crisis but its predicted collapse has yet to materialise. In fact, there have been small signs of recovery - a shock to those such as Nobel-Prize winner Paul Krugman who expected the implosion of the monetary union to occur before 2013...

The eurozone is undoubtedly in crisis but its predicted collapse has yet to materialise. In fact, there have been small signs of recovery - a shock to those such as Nobel-Prize winner Paul Krugman who expected the implosion of the monetary union to occur before 2013. Consequently, observers will be questioning whether such prophecies were misguided or simply premature.

In an article in the New York Times entitled Apocalypse Fairly Soon, Mr Krugman wrote: "Suddenly, it has become easy to see how the euro -- that grand, flawed experiment in monetary union without political union -- could come apart at the seams. We're not talking about a distant prospect, either. Things could fall apart with stunning speed, in a matter of months, not years." This was in May 2012, but fast forward seven months and the same man had to admit he was somewhat wrong.  "Europe has surprised me with its political resilience," he said in a blog post.

While his confession was anything but a recantation - he blamed the continued existence of the eurozone on an adherence to a "Keynesian script" - it served to illustrate that the fate of the union is anything but set in stone.

So what is it that is holding the eurozone together? A desire for unity? Stubbornness? Faith in the overarching principles of the euro? Or is it simply that the situation was not as dire as originally thought?

When we look closely at the crisis and predictions of the eurozone collapse, much depends on the fate of Greece. A 'Grexit', as it has been termed, would signal the end of the union. In July Willem Buiter, chief economist at Citigroup and former Bank of England policymaker, increased the probability that Greece would leave the eurozone to 90 per cent. In fact, he predicted this would happen on January 1st 2013 - a date that has been and gone.

However, Greece is still attached to Europe and its bond yield has fallen back. There has also been a determination to hold the eurozone together from key players, with European Central Bank president Mario Draghi stating that he would do "whatever it takes" to defend the euro. This pledge resulted in the bank's commitment to buy eurozone government bonds to support the currency bloc.

Other nations have also stepped into the breach to save Greece after realising a Grexit would be politically disruptive, including Germany. Barry Eichengreen, an economist at UC Berkley, explained to Reuters: "An appreciation of European politics makes you realise that everything will be done to prevent a breakup of the monetary union. It would be intensely catastrophic, economically and politically."

However, there are some that believe the failure of the eurozone to collapse this year is irrelevant - the day of reckoning will come, it's just a matter of when. Krzysztof Rybinski of Vistula University claims the eurozone crisis will deepen this year, evidenced by rising public debt levels and unemployment in fiscally volatile countries such as Greece, Italy, Spain and Portugal.

Writing in the Financial Times, Mr Rybinski explained that Greek debt will hit 200 per cent GDP in 2013, while Spain's debt is growing from below 40 per cent in 2007 to 100 per cent of GDP in 2014. "Markets believe that the time bought by indirect funding of fiscal deficits by the ECB will be used to foster structural reforms, which will lead to higher growth in the future," he stated. "But the negative effect of the massive cyclical decline of employment will far outweigh the positive impact of the structural reforms. It requires several shots of ouzo or drinking a full bottle of Rioja to arrive at the conclusion that Greece or Spain will be in better position to repay its public debt at the end of 2013 than today."

Nevertheless, it may be premature to relegate the eurozone to the annals of history. Anshu Jain, the co-chief executive officer of Germany’s Deutsche Bank, told CNBC that the eurozone will not fall, thanks to a "tremendous desire" to keep it together. In Germany alone there isn't a single party that is against the euro. This determination is likely to lead to action and with president Barack Obama one figure eager for Europe to stay in its current form, it seems there is a never ending list of power-players willing to go to great measures to protect the union. However, this doesn't mean the fate of the euro is secure and according to Matt Oakley, director at Savills, its collapse would be welcomed by the UK property market. He explained that should the currency fall, investors will flock to areas they perceive to be safe havens, primarily London.

- Wednesday 23 January 2013

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