Is This the Beginning of the End for Euro?

An EU official told CNBC Tuesday that a meeting on Friday is very likely, as Europe’s politicians have a new sense of urgency after the markets started targeting Italy.

George Osborne, the UK Finance Minister, is calling for “decisive action” following a big jump in Italian borrowing costs that has raised fears of contagion spreading from Greece to the euro zone’s third biggest economy.

European Central Bank
European Central Bank

What yet another summit of EU heads of state will achieve is anyone’s guess. So many plans have been put forward, debated and then seen as unworkable or politically unviable, that investors would be forgiven for taking this new sense of urgency with a pinch of salt.

There could be an agreement on Greek debt involving some pain for private investors, but experience suggests European politicians will struggle to agree on a deal that would actually draw a line in the sand of the entire euro zone debt crisis. Many blame their indecision for getting us into this position in the first place.

"The continued failure of European policymakers to agree on a new package to support Greece and the growing signs that larger economies like Spain and Italy are being dragged further into the crisis could mark the beginning of the end for the single currency union in its current form," Jonathan Loynes, the chief European economist at Capital Economics, wrote in a research note.

Putting the blame for the current market jitters at the door of the policy makers, Loynes said plans to rollover Greek debt appear to have run aground. He believes policy makers have finally understood that sticking plasters will not stem the bleeding.

"The plan appears to reflect a growing recognition that temporary forms of assistance, such as bail-outs and debt extensions, designed to buy Greece time to return to growth and restore its public finances to health are simply insufficient," said Loynes.

"With Greece’s debt likely to carry on rising inexorably if left alone, investors are understandably reluctant to take on long-dated bonds without more decisive action."

If we are to see some kind of shock and awe solution, something the last three years have shown is very unlikely, policymakers will need to convince investors to accept losses and convince people to actually buy again.

"In theory, quite large amounts of Greek debt could be bought back relatively cheaply. We estimate that cutting the debt/GDP ratio to the euro zone average of 85 percent would cost about 140 billion euro ($196 billion), the equivalent of only around 2 percent of euro zone GDP," said Loynes.

Unfortunately, the chances of another summit achieving such an outcome are low, given that buying back Greek debt would mean losses for banks and the ECB is unlikely to accept such a plan. Even if such an outcome was reached, would they be solving the last crisis, not the next one?

"The growing signs of contagion suggest that solving Greece’s problems may not be enough to prevent the debt crisis from continuing to deepen. For that, any Greek solution might have to be applicable to Spain and Italy as well. But Italy’s debt is almost ten times as large as Greece’s and cutting it to the euro zone average would cost 10 percent of euro zone GDP," Loynes added.

Such a plan would need fiscal union, something German and North European nations are unlikely to sign up to no matter how difficult things are in Italy and Spain. Loynes believes this could very well be the beginning of the end for the euro.

"We said just over a year ago that there was a greater than evens chance of some form of break-up or change to the structure of the euro-zone over the following five years," he said.

"If recent events are anything to go by, that change could come rather sooner than we had envisaged."