The new year promises to be make or break time for the eurozone, with dramatic integration into a new fiscal union for most and predictions that one “small country” could leave the currency area.
If 2011 went down as the “annus horribilis” for the European Union’s symbol of integration, leaders of Germany, France and debt-laden monetary partners face stark choices as they enter 2012, a decade after euro notes and coins first entered into everyday circulation.
The euro debt crisis could bring all of Europe to its knees, said French President Nicolas Sarkozy in a recent speech reflecting on contagion that spread from Greece through also bailed-out Ireland and Portugal before hitting Spain and finally Italy.
“What kind of Europe will we have left if the euro disappears, if Europe’s economic heart collapses?” he asked.
A radical transformation is under way precisely to avoid that doomsday scenario, one that would eventually blur differences even in tax and welfare systems across the core eurozone economies.
But one also that may not be without an early casualty: for instance, the chairman of the Royal Bank of Scotland, Philip Hampton, expects one “small country” to leave the eurozone in 2012.
His comment, made as Greece was wrapping up painful negotiations over a massive write-down with some of the world’s biggest banks, was echoed by others in the City of London.
At the start of 2011, the troubles in Athens, Dublin and Lisbon were considered “peripheral” problems for the eurozone as a whole.
But that was before infections at the edge of the currency area ate their way into its economic heart — all the way into France and even paymaster Germany, where the threat of a credit rating downgrade or poor take-up on the sale of government bonds served as a major wake-up call.
The crisis has taken many forms since problems first emerged in the United States late in 2007.
It affected mortgage markets, consumer spending and the real economy for householders and businesses with recession, before finally triggering panic over government debt in a Europe whose banks had become overstretched.
While the crisis was at first economic, it soon became political and heads tumbled as in the spectacular case of Italy’s Silvio Berlusconi, while social discontent manifested in the Occupy Wall Street or Indignados protest movements.
Berlusconi was the highest-profile among half a dozen EU leaders who fell to the crisis from Greece to Slovakia, with unelected former EU “technocrats” brought to power in Athens and Rome to restore market confidence.
“There is a risk that public opinion will eventually backfire,” said a senior EU diplomat in Brussels.
The coming 12 months will establish whether the eurozone has the wherewithal to protect Italy or Spain from falling into a financial abyss that could suck in the second eurozone economy, France.
In Rome, some 400 billion euros must be found in 2012 — 150 billion euros just in the first three months — simply to keep Prime Minister Mario Monti’s government afloat awaiting elections.
By mid-year, a new permanent European Stability Mechanism (ESM) is meant to be up-and-running.
This emergency fund — the successor to a troubled pot of money big enough neither to fill public finance holes in Madrid or Rome nor to attract sufficient investment from China and other emerging giants — will replace the 440-billion-euro European Financial Stability Facility (EFSF).
The boosted warchest is one tool Europe is adding to its firefighting kit, along with an increase in IMF resources, spending cuts across the continent and penalties for nations that fail to slash their deficits.
Several governments and market players also want the European Central Bank to step up its programme of buying bonds of strained governments, as they see the Frankfurt-based institution as the cure to the crisis.
Yet north and south do not see eye to eye.
For former Dutch EU commissioner Frits Bolkestein, the break-up of the eurozone is “inevitable,” given almost religious differences in the culture of a German-led bloc for whom budgetary discipline is everything and a “Mediterranean” south seeking “political” solutions to economic problems.
Banks in London – home to three-quarters of the EU’s financial services industry – have already begun contingency planning should countries return to former currencies, as have American and Asian multinational companies.
But with a full quarter of global currency reserves held in the euro, few imagine a wider meltdown.
German Chancellor Angela Merkel and Sarkozy are this year promising a great leap forward with policies that correct at last the flaws in the design of monetary, without fiscal, economic and ultimately political union.
Having failed to rewrite the EU’s treaty because of a British veto, Germany settled for a new cross-border pact due to be signed in March that would create a “fiscal union” and impose balanced budgets.
As Poland’s Foreign Minister Radek Sikorski said: “I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity.”
Much depends on how far the ECB is prepared to go.
The central bank issued cheap loans to banks worth nearly half a trillion euros ($650 billion) in a pre-Christmas splurge.
It keeps money swirling in the system, but Sony Kapoor, head of the Re-Define economic think tank, said it was merely a “Band-Aid on a deep wound.”
Policymakers hope fiscal union will be enough to convince the ECB to truly open the floodgates and become a US-style lender of last resort.
“It’s still a gamble,” admitted a senior EU diplomat.