Cracks appearing in euro currency union

Deep fault lines are running through Europe's currency union.

The euro, German Chancellor Angela Merkel warned last night, is facing its most serious crisis since its launch a decade ago. And financier George Soros warned that the 16-nation union “may not survive.”

Their comments came as European Union officials prepared to visit Athens today amid reports of an EU bailout whose effects could lead to further debt crises in the continent's troubled south.

Greece has been at the centre of a storm that has rattled currency and stock markets fearing a sovereign default because of its massive debts. While Greece has been the focus, other countries such as Spain, Portugal, Ireland and Italy are also causing concern.

The European Union's top finance official, Olli Rehn, will be in Athens today in a final effort to persuade Greece to force further cuts in public spending and services, increases in retirement ages, tax hikes and black-market crackdowns, after last week's austerity announcements failed to reassure bond markets. The harsh measures, which have already spurred unrest among the Greek public, may also be a precondition for a bailout package, in order to reassure EU taxpayers that Greeks are bearing a share of the burden.

Economy Minister Louka Katseli said that extra measures likely “will be announced soon.”

Athens only has enough funds left to keep its government solvent for two more weeks, after which it will need to refinance €20-billion ($28.7-billion) in loans due in April and May. It is currently preparing Greece's second bond issue of the year amid a collapsing credit rating and soaring borrowing costs.

Contradicting reports this weekend from German and French officials, Ms. Merkel strenuously denied that Germany, along with France and the Netherlands, is putting together a package that would see government-owned banks purchase that debt using government funds.

“That is definitely not the case. We've got a treaty that does not include any provision for bailing states out, to help them out of a jam. We can best help Greece at the moment by making clear that Greece has to do its own homework, just like it is doing at the moment.”

Ms. Merkel is due to meet with Greek Prime Minister George Papandreou in Berlin Friday, and Greek officials said yesterday that they expect a bailout deal to be announced by then.

European officials are adamant that they do not want to send the International Monetary Fund to rescue Greece using one of its bailout packages, which provide emergency loans in exchange for mandated austerity measures. This, they say, will be perceived as a failure of the euro zone to correct its own problems.

But economists warned that a homebrew bailout is unknown, and technically illegal, territory, and it could trigger a domino effect.

“The worst thing that can possibly happen is for European countries to assume the debt of Greece – the only way they can justify it is with the quid pro quo of appearing to get really tough on the Greeks, even though they don't have any instruments to do so, and that will build up resentment and bad faith and cause a series of missteps in other countries,” economist Charles Wyplosz, a monetary policy expert, said in an interview yesterday.

He is one of many observers, including some in Greece, who say an IMF rescue would be more prudent, as the organization has funds for just this purpose and would serve as a politically neutral target for Greek public anger – and, more importantly, an IMF bailout would not distort debt markets by creating investor expectations of future EU bailouts.

This is the first such crisis since the euro was launched as the currency of 16 countries a decade ago, and there is very little sense of how to resolve it.

In the past, when countries like Greece and Italy have faced debt crises, they've run the printing presses and devalued their currencies, an inflation-provoking move that causes economic devastation but leaves neighbouring countries untouched.

The euro was designed, in part, to prevent such politically motivated devaluations. But it was also designed without a central treasury: The European Central Bank cannot influence fiscal policy.

To make this work, Europe insisted on a strict rule: No euro zone country can bail out another by buying its debt. The challenge in Germany (the only euro zone economy strong enough to finance a major share of a bailout) is to do this without the appearance of state involvement.

German officials told reporters this weekend, in off-record comments, that this would likely be done by using German, French and Dutch state-owned banks, a scheme that would follow the letter if not the spirit of the no-bailouts law.

Leaders and ministers of all three nations publicly denied this weekend that any such plan is in the works.

But yesterday morning Christine Lagarde, the French Finance minister, suggested in a radio interview that a debt-purchase rescue is in the works.

“I have no doubts that Greece will succeed in refinancing itself through ways that we are exploring at the moment,” she said, suggesting that the scheme would involve “either private partners, or public partners, or both.”