Can The Euro Survive 2012?

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Includes: FXE
by: William Larson

In January, billionaire investor George Soros said, ""We now have a crisis, which in my opinion is even more serious than the crash of 2008."

Comparing the current crisis in the eurozone to the crash of 2008, Soros added, "(in 2008) you had the institutions that were necessary to control the situation, a functioning central bank, the Federal Reserve System, and a functioning treasury. In the case of the euro, you have a European Central Bank, but you don't have a European treasury. That institution is missing."

The lack of a European treasury is the missing piece of the puzzle. Without it, the ECB is limited in the assistance it can provide to eurozone member states.

In theory, the ECB could bail out those member states burdened with excessive debt by printing more money. However, that would require the approval of all 27 member states (not just the 17 eurozone that use the euro as their national currency) that make up the EU. That, of course, would include Germany, which is utterly opposed to any rescue plan that may light the fires of inflation.

Then too, there is an attitude among some EU member states not in crisis, that it is simply unfair to bail out those states that have lived beyond their means for so many years.

The Real Problem is Political

The economic crises within the eurozone are, therefore, exacerbated by the political structure of the EU. And, since no eurozone member has its own central bank, each member of the eurozone is at the mercy of an ineffective ECB.

To underscore its inability to provide real assistance to eurozone members, ECB President Mario Draghi at last week's monthly meeting said it was up to the governments of the 17-nation currency union to pare down their bloated budgets and pursue policies that would create economic growth and employment in the future for "poor, jobless young people."

Draghi said it would be unhelpful for European governments to abandon austerity efforts, which seek to contain the region's debt crisis. "Progress is being made in many countries, but several governments need to be more ambitious," he said.

But Is Austerity Working?

No, according to George Soros, and others, who fear that the kind of austerity programs envisioned by some EU members, especially Germany, "…will push Europe into a deflationary debt spiral." Soros contends, "You can grow out of excessive debt, you cannot shrink out of excessive debt."

It is difficult to compare the difficulties within the EU to those of other nations that have faced similar problems and survived. That's because the EU is not a cohesive nation.

The 27-member nations of the EU are separated geographically. In addition, they literally and figuratively don't even speak the same language. Several member states have no desire whatsoever to help other members who are experiencing economic woes.

In many ways, the EU is reminiscent of the United States before the Civil War when people would say, "The United States are. . ." and after the civil war began to say, "The United States is. . ."

That's because prior to the Civil War there was no real sense of cohesion among the states even though they were geographically contiguous. That kind of unity developed over time and involved a good deal of bloodshed in the process.

The Bottom Line

The real question is: can the EU, and the Euro, survive? Perhaps, but not without much difficulty.

Saddled with austerity measures that aren't working, chances are good that more than one member of the eurozone will soon secede and return to its former currency. Those nations seceding will likely also opt to establish their own central bank in order to print money to buy their debts.

The United States has a vested interest in the success of the EU, however. The EU represents 500 million people, which is the world's largest economy. Seventeen countries make up the eurozone comprising the world's second-largest economy, made up of approximately 330 million people.

Clearly, the collapse of the EU, or the euro, would have an impact on the U.S. economy. The eurozone by itself is the United States' third-largest export destination, accounting for 15 percent of total U.S. exports.

The worst-case scenario is a financial meltdown. If that should occur, the results would be "catastrophic," according to Soros.

The Organization for Economic Cooperation and Development agrees with the Soros assessment and estimates that if a meltdown should occur, U.S. GDP would decrease by as much as 2.07 points in 2012, and 2.77 points in 2013. Unemployment would rise 2 points.

When Fed Chairman Ben Bernanke said that he wanted to reserve QE3 for a time when it would do the most good, perhaps he was thinking about the situation involving the EU in general and the eurozone in particular. Help from the Fed would certainly be most welcome should the storms of Europe become even more menacing and threaten to damage the U.S. economy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.