As the crisis facing the Eurozone deepens, so does the pressure on Europe’s political leaders. Having spent months dithering on how to deal with the mounting problems resulting from sovereign debt crises in Greece and other EU countries, there finally seems to be the political will to halt the crisis.

In April, a deal was reached whereby the EU and IMF would provide guarantees of €110 billion to Greece. In addition, a taskforce set up by EU President Herman Van Rompuy was established. This taskforce is focusing on tighter monetary targets, more EU surveillance of economic statistics, and a move towards more co-ordinated economic governance. At the time, some thought enough had been done to appease the markets. No chance. Scenting blood, financial markets have spread the contagion to Portugal and Spain, with both having their credit ratings downgraded, increasing the cost of their borrowing. Meanwhile, rioting on the streets continues in Athens. A toxic combination of incompetent economic governance and the brutal herd mentality of the markets have caused the biggest crisis to face the Eurozone since its inception.

This raises several questions: will the Eurozone survive, who is to blame, and what measures can be taken to ensure this crisis is not repeated?

The answer to the first question is – despite the crowing of eurosceptics who fail to appreciate the dreadful impact on Britain’s exports and jobs of the euro collapsing – yes. At a political level, for the same reason as governments across the world bailed out financial institutions two years ago, the Eurozone is simply too big to fail. It is also the most iconic symbol of the European Union. Don’t forget that, even in this crisis, many EU countries are desperately trying to meet the economic criteria allowing them to join. To Estonia, expected to join the Eurozone in January 2011, joining the Eurozone is a great source of national pride.

There has been widespread ‘Greece bashing’ in the media, and it is true that Greece lived beyond its means for years and, more importantly, deliberately cooked the books so that it could join. In retrospect, Greece should not have been allowed to join the euro. However, Greece’s plight is a symptom of a wider problem rather than the problem itself. The reality is that we have a ‘two tier’ Eurozone, composed of competitive and fiscally disciplined countries predominantly in Northern Europe and Scandinavia, and countries such as Portugal, Italy, Greece and Spain (commonly known as the PIGS) whose productivity is much lower. The idea was that the Stability and Growth Pact, which establishes limits on government debt as a proportion of GDP (60 per cent) and budget deficits (3 per cent) would act as a safeguard. After twelve years, it has been found to be defective.

The crisis has also exposed the fact that the cosy Eurozone club was not immune from speculative attack. Instead of speculating against individual currencies, financial markets have seen that they can make money (and wreak havoc in the process) by betting on government bond spreads. That is why Greece has to pay double the amount Germany does to service its debts. The truth is that many saw Eurozone membership as a club that would protect them – a bit like ‘Noah’s Ark’. They were wrong.

So, what do we do? We need structural reforms by Eurozone countries. We have to be able to trust governments’ economic forecasts and statistics, so statistical governance must be tightened. There must be closer economic co-ordination between Eurozone countries. If we are going to have economic and monetary union, we can’t have a situation where countries like Germany sit on massive surpluses with their government doing nothing to stimulate their low domestic consumption when others are trying to increase their exports. That is little more than ‘beggar thy neighbour’ economics.

We also need more transparency on the role of derivatives, short-selling of shares, credit default swaps and, above all, the credit rating agencies which have helped cause this crisis. These financial instruments must be more tightly regulated, and properly understood, to prevent future crises.

EU leaders must also flesh out the detail of the €750 billion emergency fund for countries that face such crises. This ‘emergency fund’ is in fact very similar to the idea of a European Monetary Fund (EMF) dreamt up by Roy Jenkins in 1978 when the European Monetary System (the forerunner to the euro) was set up. It makes perfect sense. A group of, potentially, 27 countries should have its own equivalent of the IMF. Now it seems that, with Eurozone countries providing over €400 billion, the IMF €250 billion, the EU budget being used as collateral to borrow a further €60 billion and small contributions from other EU countries, Europe’s political leaders are finally recognising the magnitude of the problem. This emergency package, which is the EMF in all but name, plus structural reform to the Eurozone should do the trick.

For the UK, the Eurozone crisis is already causing problems. Countries across the EU are being forced into largely unnecessary austerity budgets to pacify the financial markets and credit rating agencies, fearful that they, too, could have their credit rating downgraded. My fear is that this could lead to the Con-Dem coalition’s ‘emergency budget’ this month introducing brutally harsh spending cuts in a bid to appease the rating agencies. This could lead to a rapid rise in unemployment. Moreover, were the Eurozone to fail, Britain’s exports, most of which go to Eurozone countries, would instantly become more expensive. This would lead to further job losses.

But, the Eurozone will survive because its problems are surmountable and too much political capital has been invested in it. Were it to fail, the UK would be badly damaged- our economy is still fragile – and the single market with its single currency makes it easier for us to export our way back to prosperity. For it to fall apart would be a catastrophe for Britain – and the rest of the EU.

Photo: rockcohen 2008