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02/09/2010

Men like Wilhelm Nölling, former member of the German Central Bank Council, and Wilhelm Hankel, an economics professor critical of the euro, have been out of the spotlight for years. In the 1990s, they fought against the introduction of the common currency, even calling on Germany's high court to prevent the creation of the euro zone. But none of it worked.

Now both men are in demand again, and the old euro critics' beliefs are more relevant than ever. Were the skeptics right back then, when they said Europe wasn't ready for the euro zone? Were the differences too great and the politicians too weak to ensure a strict and stable course?

Is the euro's high flight over now too? The news these days is alarming. It's causing a commotion on financial markets and intense discussion in capitals across Europe, as well as in Frankfurt, seat of the European Central Bank (ECB).

Brussels took a hard line with Athens last week. Greece must cut costs drastically under close European Union supervision, a sacrifice of a share of its sovereignty. Risk premiums for Greek government bonds have risen drastically, and the country has to pay higher and higher charges.

The Possibility of State Bankruptcies

Accruing debt is becoming increasingly expensive for other countries in the euro zone as well, among them Portugal and Spain. The southern members of the euro zone are especially being eyed with mistrust. Speculators are betting that bonds will continue to fall and that, eventually, the countries won't be able to borrow any more money at all. State bankruptcies are seen as a possibility.

"We've reached a point where it's possible to deal individual countries a lethal blow by downgrading their credit and boycotting their government bonds," Nölling warns.

Many are now wondering how the stronger euro-zone countries should react -- whether it's possible to help the weaker ones without jeopardizing themselves and the common currency. Furthermore, there is a risk that euro-zone members will continue to grow apart economically, a trend that could cause the monetary union to eventually collapse.

Doing nothing is not an option. In light of the national debt in Greece, Portugal, Spain and Ireland, the euro zone is in danger of transforming from a "common destiny to a common liability," Nölling says.

And so it won't be any ordinary meeting when finance ministers from the 16-euro zone countries meet for a regularly scheduled get-together in Brussels next Monday. The European Commission plans to assign each country homework to be completed in the coming years.

Cohesion and Stability

The Commission doesn't hold Greece solely responsible for the current euro woes. Experts close to Economic and Monetary Affairs Commissioner Joaquín Almunia say nearly every participating country is compromising the cohesion and stability of the common currency.

"The combination of decreasing competitiveness and excessive accumulation of national debt is alarming," the experts wrote in a recent report, adding that if the member countries don't get their problems under control, it will "jeopardize the cohesion of the monetary union."

Differing economic development within the euro zone and a lack of political coordination are to blame, they say. In the more than 10 years since the euro was introduced, the Commission states, it has become clear that simply controlling the development of member states' budgets is not enough. What that means, more concretely, is that the stability provisions stipulated in the Maastricht Treaty to regulate the common currency aren't working, and member states need to better coordinate their financial and economic policy measures.

That is precisely what euro skeptics have said from the beginning -- that a common currency can't work in the long run without a common economic and financial policy. The member countries' governments ignored these objections, unready to give up a further aspect of their national sovereignty.

Now politicians are facing a difficult decision: Should they continue as they have, thus potentially undermining the euro's ability to function? Or should they yield a portion of their national sovereignty to Brussels?

Without common policies, the individual countries drift further and further apart. Before the euro was introduced, exchange rate adjustments served to dispel tensions. Now the common currency zone lacks the option of adapting by revaluing currencies.

Watching with Alarm

EU officials are watching with alarm as the various euro-zone countries' competitiveness diverges sharply. The differences are especially large between countries like Germany, the Netherlands and Finland, which are characterized by current account surpluses, and countries with high budget deficits. Along with Greece, this second category includes especially Spain, Portugal and Ireland.

These countries' competitiveness has dropped steadily since the euro was introduced. They lived on credit for years, seduced by the unusually low interest rates within the euro zone, and imported far more than they exported.

When demand collapsed in the wake of the global financial crisis, governments jumped in to fill the gap, with serious consequences -- debt skyrocketed. Spain's budget deficit was at 11 percent last year, while Greece's was nearly 13 percent. Such high debt is simply not sustainable in the long term.

In the past, the solution for these countries would have been to devalue their currency, which in turn would make imports more expensive and exports cheaper. Such a move would stimulate their national economies and strengthen their competitiveness.

Now, however, these countries must submit to a drastic therapy regime at the hands of the European Commission. They need to balance their budgets, while simultaneously creating more competition on the labor and goods markets.

The directives from Brussels translate into difficult sacrifices for the citizens of the affected countries. Employees will have to scale back wage demands for years, and civil servants will see their salaries cut. Ireland has already embarked on this path; Greece and Spain will follow.

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• Part 1: How Brussels Is Trying to Prevent a Collapse of the Euro
• Part 2: Is Germany to Blame?