Black clouds threatening the euro's survival

The biggest victim of the global housing and credit bubble may be the euro — the single currency of 16 European nations. Having just celebrated its 10th birthday in a free-fall, the euro is being exposed for all of its structural weaknesses.

The euro is managed with a common monetary policy. But a fractured fiscal and political structure has left it without a full toolbox to fight hard times. And this chink in the armor is threatening to make the euro's life-span short.

Members of the European Union's monetary system (the single currency) are left frozen in a rigid, inflexible and arguably faulty regime. But lack of flexibility is not even the most dangerous problem the euro member countries are facing. Even more dangerous to the euro's future existence is the death-spiraling plunge of neighboring eastern and central European “non-euro” countries.

I see two black clouds threatening the euro's survival …

Black Cloud #1 — Pressures from Non-Euro Countries.

When the economic engine of your economy stalls (i.e. global demand for your exports evaporates) and the fragility of your financial system is glaring, investors flee and speculators wage an attack on your currency.

And this is precisely what's taking place in the currency markets right now …

Emerging market economies in Europe have been hammered, driving DOWN the value of their currencies and driving UP the value of the foreign-currency denominated debt that consumers and institutions in these countries are holding.

Black Cloud #2 — Vulnerability of the Euro Concept

Aside from the pressures being cooked up on the periphery, the euro member countries are in trouble for all of the reasons. Milton Friedman, one of the most influential economists of the 20th century, cited prior to the euro's inception 10 years ago.

I'll paraphrase four of Friedman's statements and follow each with what is going on now:

1. A one-size fits all monetary policy doesn't give the member countries the flexibility needed to stimulate their economies.

2. A fractured fiscal policy forced to adhere to rigid EU rules doesn't enable member governments to navigate their country-specific problems, such as deficit spending and public works projects.
3. Nationalism will emerge. Healthier countries will not see fit to spend their hard earned money to bail out their less responsible neighbors.

4. A common currency can act as handcuffs in perilous times. Exchange rates can be used as a tool to revalue debt and improve competitiveness of one's economy.

Under the euro, weak member countries are helpless. Italy has a history of competitive devaluations of the lira during sour times. Now, in the euro regime, its economy is left flapping in the wind.

Milton Friedman predicted that the euro would collapse within 10 years of its inception. As Jack has written in past Money and Markets columns, Milton Friedman saw the vulnerability of this concept coming and predicted the euro's demise within a decade.

Today, the most challenging issue facing the euro might be addressed in this statement:

“Political unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.”

Germany, the core of the euro and the rich uncle to its euro-member partners, appears increasingly intolerant of the less responsible, less viable partners. Could they make an unexpected departure from the currency union?

If so, how would be the euro existence and its member countries?