Contemplating a breakup of the euro zone

January 26, 2011: 1:39 PM ET

With all the troubles developing around parts of debt-ridden Europe, could it possibly get worse? Some are actually thinking the unthinkable: A breakup of the 17-member euro zone.

Eurozone map in 2009 Category:Maps of the Eurozone

Image via Wikipedia

The European Union just celebrated its seventeenth birthday, and it's clearly hit its awkward phase. Though the value of the euro has strengthened some against the US dollar in recent weeks, it has undergone a very bumpy ride on signs that Europe's sovereign-debt crisis will damage the region's banks and force the entire area into a prolonged period of slow economic growth. In June, the euro approached a four-year low against the US dollar, touching $1.211 on June 1 – the lowest since April 2006.

The question now is just how many more birthdays does the EU have without a dismantling of the euro zone? A break-up of the 17-member zone is possible, but not probable, according to many economists. If it were to happen, the catalyst will be political, not economic, said John Taylor, founder of FX Concepts at a forum in New York yesterday that brought together academics, analysts and Germany's deputy finance minister Joerg Asmussen, who called the euro a "cornerstone" of European integration and reiterated the country's support for the common currency.

Debt-ridden Greece and Ireland have received multi-billion dollar bailout packages in hopes to keep the crisis from spreading. Spain and Portugal have faltered, leading some to question just how many more bailouts the euro zone will be able to handle.

Taylor says while a euro zone break-up probably won't happen anytime soon, one of the developments to watch for is how Europeans respond to unprecedented measures to tighten spending. Recently, Greece's parliament approved its 2011 budget that included aims to cut the fiscal deficit to about half of last year's level. The cuts were indeed deepest in decades, prompting protests by unions. But Prime Minister George Papandreou has maintained his popularity so far.

Surely Greece and Ireland spent too much when economic times were good. But the possible side-effects of strict austerity measures are very slow growth and even negative economic growth. And if it gets to the point where it cuts into the relatively comfortably lifestyle citizens have enjoyed in recent years, there could be a political price to pay, Taylor told the audience at the Bloomberg European Debt Crisis conference. Wage cuts, as we've seen in Greece, have not gone well with unions. Virtually no country wants to see a break-up, but he said it's possible that frustrations could escalate to the point where constituents feeling the weight of a slow-growing economy could start pressuring elected officials to part ways with the euro zone.

It remains to be seen how the debt crisis pans out, but Taylor's remarks highlight the fact that Europeans could simply choose not to belong to the euro zone. Greece and Ireland might be worse off adopting a new currency, but if budget cuts lead to growth so anemic that it makes its citizens miserable, leaving the euro zone might just become a more real -- albeit not necessary better -- option.

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Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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