January marks 20 years since the launch of the euro, but whether it's been good for the region and whether it can survive another 20 years unscathed is hotly contested.
An Economic and Monetary Union (EMU) had long been an ambition of Europe's integrationist politicians and was seen as a natural progression to the EU's ideals of "ever greater union." Hence, in January 1999, the euro — a unique experiment in which countries in Europe would give up their national currencies, adopt the single currency and cede control of their monetary policy to a newly created, supranational European Central Bank (ECB) — was born.
The ECB had been established a year before to define and administer monetary policy for the euro zone and had the chief responsibility to maintain price stability with an inflation target of below but close to 2 percent. In the meantime, members retained control over their fiscal policies although there are overarching rules on these in the EU.
At its inception in 1999, the euro was adopted by 11 EU members, but it was then joined by Greece, Slovenia, Cyprus, Malta, Slovakia, and then the Baltic states Estonia, Latvia and Lithuania followed. Euro notes and coins were officially introduced as legal tender in 2002.
Twenty years on, the euro is now used by over 340 million Europeans, with more EU countries expected to join the union, and is one of the most important currencies in the world.
Monetary union has been tested since its inception with first the global financial crisis, and subsequent sovereign debt crises in the euro zone, testing how far the region's politicians were willing to go to save the euro zone, essentially a political project embodying the EU's aims at "ever closer union."
A 'slightly mad' project
Analysts and economists shared their thoughts with CNBC on how the euro has fared and what it's future might hold. One thing's for sure with the euro, they note: It's too late to turn back now.
"The euro's main achievement is still being here, and it's very likely that it's here to stay," Constantine Fraser, European political research analyst at TS Lombard, told CNBC.
"This slightly mad project of a supranational currency union with wildly different economies within it has lasted 20 years and brought these economies and countries closer together."
Fraser said that the biggest impact the euro has made in the region is that "it has enormously raised the cost of backtracking on the European project."
Even most euroskeptics can see that the costs of exit for a euro zone state would be huge, and the only real alternative to exit is that there has to be further integration. They've given up on the idea of turning back the clock to a time before the single currency.Constantine FraserEuropean political research analyst at TS Lombard
The benefits of the euro quickly became apparent in its early years with the most obvious advantages being the removal of transaction costs (the cost of exchanging currency), increased price transparency and the simplification and stabilization of cross-border trade, investment and business.
"Cross-border supply and cross-border economies have grown up around it as a result of the euro," Fraser noted.
The euro has also thrown up disadvantages, however, with critics saying its "one policy fits all" approach is unfit for a region with massive variations in its member economies. The loss of an independent monetary policy also means that members cannot devalue their own currencies in order to regain competitiveness. This has been a major problem for countries like Greece.
Rules on budget deficits, essentially limiting what countries can borrow, have also led to criticisms that it's harder for these countries to bring about economic recovery and that they then have to resort to austerity measures (which themselves can cause recessions).
The costs of leaving the single currency would be high but nonetheless, recessions and crises within member economies have led to some nostalgia for former currencies and resentment at the loss of economic independence, as we saw in Greece amid its bailouts.
A 'seriously incomplete' currency union
Economists tend to agree that a lot of the problems that the euro, and its adherents, has experienced were not foreseen by its creators. Monetary union also threw up challenges that European economies had not experienced before, according to Felix Huefner, a senior European economist at UBS.
"In the '90s, the challenges (for European countries) were more focused around exchange rate volatility. With intra-euro exchange rates fixed since 1999, any adjustments in competitiveness had to be done internally with wage restraint and structural reforms," he said last week.
"One lesson over the last 20 years is that that has proved to be tougher than initially thought. The recent pushback against structural reforms in France is just one example," he said.
While structural reforms remain a bone of contention in the modern-day euro zone, it's first major challenge a decade ago was the global financial crash of 2008 and subsequent sovereign debt crises (of varying degrees and causes) in Greece, Portugal, Ireland, Spain and Cyprus. Italy was also fragile but did not request any financial help although it remains a risk in the region.
With major economies in the euro zone at risk from economic collapse, it fell to the ECB, along with the European Commission and International Monetary Fund (collectively known as the "troika") to effectively save the single currency project by giving financial bailouts to euro zone members in order to prevent contagion and further collapse of the entire monetary union.
J.P. Morgan economists David Mackie and Greg Fuzesi noted that the ECB's role in the monetary union evolved in the first decade of its existence.
"In the first decade, the ECB achieved its objectives, at least in terms of growth and inflation. But beneath the surface, stresses in the euro area were building in the form of large intra-regional financial imbalances driven by excessive leverage in a number of individual countries, Spain, Portugal, Greece and Ireland," they said in a note last Wednesday.
"For all of the second decade, from 2009-2018, the ECB was dealing with the macro consequences of the unwinding of the imbalances that had built in the first decade," they said.
Existential crisis
The sovereign debt crisis showed that the euro zone was established without adequate thought given to the institutions that a currency needs, according to TS Lombard's Fraser, who added that this brought about something of an "existential crisis" for the currency between 2010 and 2015.
"The obvious failure of the euro is that it's a seriously incomplete currency union."
"It was set up with only some of the institutions that a currency requires. That, and policy mistakes by member states such as the unnecessarily aggressive stance on deficit reduction (and to a lesser extent mistakes by the ECB like the 2011 rate hikes) caused a massive depression in the region," he noted.
"The euro went through an existential crisis from 2010-2015 and it came close to falling apart entirely in 2011/2012."Constantine FraserEuropean political research analyst at TS Lombard
Amid soaring bond yields and increasing fragility, Europe's commitment to the euro zone project was made no clearer than in July 2012 when the president of the ECB, Mario Draghi, made his now infamous "Whatever it takes" speech credited with "saving" the euro.
A week later the ECB announced a program to buy the bonds of distressed euro members (the policy was known as Outright Monetary Transactions) if necessary. OMT has never been used but the announcement alone, along with Draghi's remark, was seen to have helped to lower bond yields in the euro zone.
"Draghi's pledge to do 'whatever it takes' gave the euro zone the central bank backstop it needed, and was also an important symbolic moment in making clear that the euro zone was here to stay and policymakers were committed to its survival," TS Lombard's Fraser notes.
Still, the euro zone's integrity was again threatened in 2015 when Greece came close to crashing out of the single currency at the height of its crisis. A majority of Greeks rejected taking another international bailout from the troika in a referendum but as the potential costs of leaving the euro (and a likely debt default) became clear, the government backtracked and it reluctantly signed up to a third bailout with onerous conditions.
Extraordinary measures
In late 2014, the ECB embarked on a series of bond-buying programs that morphed into a fully-fledged "quantitative easing" asset purchase program that has only just been wound down in December 2018. The idea of QE was to boost money supply in the euro zone, bank lending and consumer spending. At the end of QE, the ECB has accumulated over 2 trillion euros worth of assets.
While QE helped the region to recover from crisis (to what extent is debatable), the region's economic turmoil made it clear that more institutional reforms and more integration were needed in order to prevent — or contain — any future financial shocks.
Replacing earlier funding programs and changing the way bailouts would be handled, the European Stability Mechanism was created to cover any future lending to euro members in financial difficulty and was used in 2012 and 2013 for Spain and Cyprus' bank recapitalization programs.
In order to prevent future financial crises — or at least to see them coming — and to prevent a so-called "doom loop" between governments and European banks (a loop of mutual reliance and fragility), a banking union was also initiated in 2012 so that European banks would be subject to more supervision and rules from the ECB.
Along with this 'Single Supervisory Mechanism' there is a second pillar of the banking union, the 'Single Resolution Mechanism' (SRM). This contains a fund (a 'Single Resolution Fund'), financed by contributions from the banking sector, that was created to resolve failing banks in the region, and to shore up the whole financial system.
The process is not yet finished, however.
"We've seen the creation of a banking union with common (banking) supervision and a resolution fund (the Single Resolution Fund), but there is still no European deposit insurance scheme in place," UBS' Huefner said.
Many analysts argue that the euro zone needs to become a fiscal union — a centralized approach to revenue collection and expenditure which would entail a shared budget, fiscal discipline and shared debt — as well as monetary union, in order to survive. Those in favor of fiscal union argue that it would promote more stability and equality in the region, and that without it the euro zone remains vulnerable to economic shocks and imbalances. Critics say it cedes more sovereignty to the euro zone and takes away governments' ability to set country-specific spending and borrowing levels.
While a fiscal union is seen as a logical step in the quest for ever closer economic and political ties, and is promoted by the likes of French President Emmanuel Macron, it is nonetheless controversial. While Germany does not balk at the idea of a euro zone budget or euro zone finance ministry, for example, it is less than keen to see debt-sharing in the region.
The mutualization of debt via the issuance of a euro zone bond could bring down borrowing costs for the region's weaker countries like Greece but it is a thorny issue for Germany which currently has low borrowing costs and fears becoming responsible, and having to effectively underwrite, its weaker, riskier neighbors.
Against this backdrop of resistance over more fiscal integration, UBS' Huefner said the euro zone "is not yet complete."
"Going further requires more burden-sharing, i.e. joint insurance of risks across euro zone countries. But as we've seen, there is no consensus how far to go — France is more in favor of this while there's more resistance from Germany," he said.
Nonetheless, Huefner added that the euro zone project was essentially a political project rather than economic and that there is a commitment to ensure its survival.
Ensuring the euro's survival
After a prolonged period of expansionary monetary policy, the ECB is now pursuing the "normalization" of policy, essentially a return to conventional tools — like interest rates — at the center of its policy.
Despite its massive asset purchase program over the last few years, inflation remains low in the euro zone (at 1.6 percent in December, down from 1.9 percent the previous month) amid a period of uncertain and mainly weak economic growth and this is a concern for the central bank.
The outlook for the region in 2019 is not great, according to Daniel Lacalle, chief economist at Tressis Gestion. He told CNBC last Wednesday that the euro zone economy is likely to enter a period of stagnation this year as France, Italy, Germany and Spain post weaker growth figures than expected.
The likely rise in bond yields may also affect credit growth. Governments have completely abandoned any reform agenda and the rise in public spending combined with lower tax revenues and growth might erode the confidence in the solvency of the euro zone major economies.Daniel LacalleChief economist at Tressis Gestion
"While weak commodity prices may help the euro zone avoid a recession," he noted, "credit risks will probably intensify as the effect of ECB purchases ends and political unrest rises."
After a decade of recovery from the financial crisis, political instability is now a larger and more unpredictable threat in the euro zone, J.P. Morgan's Fuzesi and Mackie said, noting that "the main challenge of the ECB's third decade is likely to be ensuring the survival of the monetary union, not due to financial market stress, but against the backdrop of significant populist pressure."
Italy is a prime example of the charge of populist, or grass-roots politics, and how they're becoming increasingly influential. There, a coalition of the right-wing Lega party and the anti-establishment Five Star Movement formed a government last June and they have wasted no time challenging the status quo in the euro zone in terms of spending plans and reforms as it tries to revamp Italy's stagnating economy. The euro zone's third largest economy is a major threat to (and potential failure of) the euro zone, TS Lombard's Fraser said.
"The single biggest and ongoing failure, or problem, or headache in the euro zone is Italy. It cannot grow, it has a creaking economy, it been out-competed by the likes of China and it has an aging population. If it had its own currency it could (devalue it) and become more competitive but it can't do that in the euro," he said.
Likening Italy to a sovereign state that's become more like West Virginia, Fraser said a lack of unified strategy or rescue plan when it comes to Italy reflected a wider lack of solidarity in the euro zone and one that could prevent more integration.
"Europeans don't yet feel 'European' enough to be happy with large fiscal transfers from one part of the euro zone to another," he noted.
"The euro zone is incomplete, it has all these problems and it needs to get deeper, it needs to integrate more. It can't stand still otherwise it could fall. There is the political will to make sure it survives but how fast it can move towards more integration, by making small incremental changes, is unknown," he said.
- Graphics by CNBC's Bryn Bache.