Will the Euro Survive? Central Bankers Say Yes, for Now

At a discreet farewell dinner in Davos for Swiss National Bank chief Philipp Hildebrand, a handful of guests including central bankers past and present were handed blank sheets of paper.

Before they began eating they were asked to write down the probability, in their view, that the euro would collapse in the next five years, according to two of those present at the meal. They were also asked what likelihood they thought financial markets assigned to such an event.

The result, announced at the end of the dinner, can hardly have helped the Europeans' digestion.

On average the guests - from Switzerland, the euro zone, North America and Latin America - saw a 21 percent risk of the 17-nation single currency breaking up in five years, one participant said. They concluded markets envisage a 35 percent chance the euro will not exist in its current form.

It was not possible to corroborate the figures with other diners who cited the private nature of the event. Some declined to reveal the content of the discussions at all.

The straw poll among current and recently retired policymakers reflected a wider mood of short-term relief tinged with longer-term doubt among the world's movers and shakers at this year's World Economic Forum session in the Swiss Alps.

In contrast to pre-Christmas fears of an imminent breakdown, few now expect the euro to blow up suddenly this year after the European Central Bank flooded banks with cheap long-term money.

"We know for sure that we have avoided a major, major credit crunch, a major funding crisis," ECB chief Mario Draghi told Davos delegates. Bankers concurred.

In another hopeful sign, Greece says it is close to a deal in which private creditors would "voluntarily" accept a roughly 70 percent write down on their government bond holdings as part of a second bailout package for Europe's worst debtor.

The alternative to this "soft" debt restructuring would be a potentially chaotic hard default, which banks and governments are desperate to avoid if possible.

Even if Greece is rescued again, much remains to be done to restore market confidence in the euro's long-term survival.

High-level private meetings over four days in Davos helped many appreciate that progress is being made in Europe.

Away from the media glare, a secret steering group of top European and U.S. policymakers, the ECB's Draghi and IMF Managing Director Christine Lagarde discussed how to strengthen financial defences to protect the euro zone.

The group, including finance ministers of France, Germany and the United States, discussed a plan to assemble a combined war chest of 1.5 trillion euros by the time of the International Monetary Fund's spring meeting in April, one participant said.

That depends on Germany agreeing to let a new 500 billion euro permanent rescue mechanism run in parallel with an existing bailout fund that has about 250 billion euros left after lending almost as much to Greece, Portugal and Ireland.

Chancellor Angela Merkel gave no clear signal of acceptance in her keynote Davos address, challenging the assumption of some policymakers and market participants that a doubling or tripling of existing rescue funds would restore real trust.

Germany wants to be sure it has nailed down a new treaty on stricter budget discipline in the euro zone and a rulebook for the permanent bailout fund before it shows its hand on extra money, EU officials say.

"Actually people are slightly more optimistic at the end of the week than at the beginning," British finance minister George Osborne, a member of the euroskeptical Conservative party, said.

Yet a note of caution is in order. Many delegates left last year's Davos too thinking the crisis was nearly over.

This year, the mood was darkened by a bleak outlook for economic growth, with rising unemployment and deep recession in southern Europe widening a continental divide and making efforts to balance public finances even more difficult.

Participants were most impressed this time by the decisive action of the ECB to shore up teetering banks.

As a result, "there is not going to be a Lehman-style event in Europe," Canadian Central Bank chief Mark Carney said, referring to the collapse of the U.S. investment bank in 2008, that triggered the global financial crisis.

Markets had been baying for the ECB to step in as a lender of last resort to debt stricken countries, but the bank had fired its "bazooka" indirectly via the banks to avoid breaching its treaty mandate.

"The euro will continue to exist in its current form. It is highly likely that all countries will remain in. I think the odds are it just stays together," said Gary Parr, vice chairman of U.S.-based investment bank Lazard Ltd

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Photo: Fabrice Coffrini | AFP | Getty Images Participant at the World Economic Forum (WEF) annual meeting snack under a sign on January 25, 2012 at the Congress Center in Davos.

Parr said American scepticism about the euro zone's ability to mend itself was a mirror image of the subprime crisis of 2007-9, which was primarily felt in the United States.

In an informal show of hands at a closed-door session on global currencies, a majority of participants said they believed in the long-term survival of the single currency. Those who affirmed the euro would still be around in 10 years included a non-EU central banker and a top European regulator.

Market doubts about the euro focus on Europe's ability to rein in fiscal excesses at a time of slow growth and high unemployment, and a growing gap in economic competitiveness between northern and southern Europe.

"The market says we may have confidence for six months but we are not sure we have confidence for 5 or 10 years," said Samuel Di Piazza, vice-chairman in Citigroup Inc's

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U.S. Treasury Secretary Tim Geithner, on his sixth visit to Europe since last September, called publicly for the euro zone to increase the size of its financial firewall.

Bankers who met Geithner said the fighting fund should be big enough to cover the borrowing needs of Europe's weakest debtors for the next three years to deter speculation and restore market calm.

Italy, the euro zone's biggest worry, has 1.9 trillion euros of public debt , too big to be rescued were it to default.

Many Davos delegates praised new Prime Minister Mario Monti's efforts to shake up the Italian economy, balance the budget and overhaul inefficient state structures.

But some participants remain convinced the challenges Europe has to face to spur growth are incompatible with the austerity that Germany is advocating and will ultimately undermine the single currency.

"The euro zone is a slow-motion train wreck," said economist Nouriel Roubini, nicknamed Dr Doom after he predicted the U.S. subprime crisis.

Roubini sees Greece leaving the euro within a year, possibly followed by Portugal. He told delegates there is a 50 percent chance of the bloc breaking up completely in the next 3-5 years.

In the same camp, Gerard Lyons, chief economist at Standard Chartered

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[STAN-GB  Loading...      ()   ], called the currency "fundamentally flawed," drawing a sharp rebuke from former EU Trade Commissioner Peter Mandelson, who said a euro collapse would do "colossal" damage.

"That would be a disaster," said Dutch Rabobank Chairman Piet Moerland. "I am completely convinced the politicians want to keep the euro zone as it is."