Is the euro dead?

When the euro was being hashed out by Europe's leaders of yester-year they were creating a currency that would be the equivalent to the Hummer of the motor world.

The euro would rival the dollar as the world's most widely used currency and would become the icing on the cake of a united Europe.

But a mere 10 years since it came into circulation, is the euro is at risk of collapse?

One of the most interesting debates in the midst of Europe's sovereign crisis has been the outcome for the currency. Some have called for the end of the euro over the past year.  However, it has shown remarkable resilience and it is still worth 40% more than a dollar.

But a year into the crisis and the harsh truth is finally coming out: Greece is insolvent. Ireland, Portugal and even Spain look increasingly vulnerable.  If the Iberian nation falls then it can only be a matter of time when Italy follows suit, maybe even France would suffer.

That would leave Germany, the Netherlands, Austria and Finland as the only members in the currency bloc not in need of financial assistance.

This may be an extreme scenario, but if things were to get this bad, you can imagine that the euro would not be able to exist in its current form.

The trouble with Greece

Right now we don't know what will solve Greece's chronic fiscal problems. We can assume that Greece won't be allowed to go bankrupt next month when some large debt repayments come due. Instead, the EU, led by Germany, the ECB and the IMF will come to the rescue and release funds.

If they don't then the alternative is carnage in the financial markets. If Greece misses a payment it will be labelled as having defaulted.

The fact that the various branches of the EU could let one member go to the wall would lead to questions of the strength of the union and the future of the currency.

In the immediate aftermath of the Lehman Brothers bankruptcy in 2008 the euro crashed 15% against the dollar; if the problem happened in its own backyard you could imagine the impact on the single currency would be even more severe.

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So what next?

At this stage there are three outcomes for the euro.

The first outcome is that the single currency dies from a thousand cuts. Every time Greece looks like it is taking a step towards disorderly default then the euro gets hit. Eventually it weakens so much that it causes inflationary pressure and international investors no longer treat it like a world-class currency.

This makes Germany, a nation of savers, mad because it hates inflation and wants a strong currency for the prestige. So it dumps the euro on the weaker peripheral states and reverts to the Deutschmark, possibly taking Austria, the Netherlands et al with it.

The second scenario is far more brutal. Greece runs out of money, panic ensues, financial markets crash. The union breaks up leaving the currency null and void, as each country reverts to its former unit of value.

The final outcome is that the euro survives and the sovereign debt crisis goes down in history as a minor blip. For this to happen Greece cannot default.

Spain and Italy are much more fundamentally sound than Greece, Portugal and Ireland. If Greece can stave off default and the EU and ECB can make it look like the country's fiscal position is improving then this buys time for Spain and Italy to get their fiscal houses in order.

Light from the east

This scenario also depends on China. Essentially the single currency's stability in the past year is down to continued demand for euros and euro-based assets from China.

It is essentially the world's greatest piggy bank. It has been supplementing the US's debt binge for years to the tune of $1 trillion and wants to diversify its eggs out of one basket. The only market and currency deep enough to provide what China wants is Europe and the euro.

China's continued interest in the currency bloc throughout this crisis suggests that Beijing thinks it will pull through.

This support should stem the euro's decline, and may even solve the crisis: If China has faith in Europe's abilities to pay back its debts then other investors might follow. This might not save Greece, but it could protect Spain and Italy.

Traditionally the Chinese take a long-term view on their investments. They still have faith in Europe; perhaps the naysayers calling the euro's demise should instead follow the money.

(Source:http://uk.finance.yahoo.com/news/Is-euro-dead-yahoofinanceuk-2986780758.html)

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