For the euro zone, breaking up is hard to do

MILAN —

Still unlikely, but no longer unthinkable.

The breakup of the euro zone — once the domain of economic theory and cranky euroskeptics — is increasingly becoming a real hypothesis as pressure mounts from the spiraling debt crisis that started in Greece.

Just weeks ago, a breakup scenario suggested the expulsion or departure of fiscal weaklings like Greece or Portugal who can't keep their debts from dragging down the group. But now markets have started to wonder about the big members: Could Germany jump; is France ready to bolt?

The creation of a common currency in 1999 capped a historic dream of European integration born of the conflict of two world wars. More than just a financial tool, the euro has become the symbol of European cooperation and harmony.

That taboo is suddenly wavering as the debt crisis threatens the European Union (EU) with economic meltdown. Increasingly, people ask not only whether a nation could bolt the currency, but whether the euro could break up.

"I think it is still very, very unlikely in the short term," said Marco Annunziata, the London-based chief economist for Italy's Unicredit. "But I think what is becoming increasingly obvious is that the euro zone in its current state will not work."

The temptations to leave are clear for the smaller, heavily indebted members. Greece, near bankruptcy, could immediately restore its trade competitiveness by letting a restored drachma devalue — instead of the current ugly process of forcing down wages and prices for years.

Yet the lure could also be significant for a larger member.

Under one scenario, Germany — fed up with having to shoulder others' debts and unhappy at future looser monetary policy by the European Central Bank — could go it alone based on its own fiscal discipline and the historic credibility of its Bundesbank central bank.

In either case, the costs of unraveling a currency union of 16 countries that makes up the world's No. 2 single market could be very high.

Weaker countries would face immediate financial instability. Yields on government bonds would rise, making debt more expensive. There was a taste of that when the euro sagged on rumors, quickly denied, that France was considering a return to the franc.

Rewriting computer code and changing ATMs would be only the start, suggests Barry Eichengreen, a University of California, Berkeley economist, in his widely cited 2007 paper, "The Breakup of the Euro Area."

Chain reaction

Once investors sniffed the likelihood that a country would leave, they would rush for the exits to avoid seeing their euro-denominated assets converted and devalued, causing a financial collapse. And that wouldn't be the end — a defector might face political retaliation from angry EU members.

Yet much depends on who leaves and why. A German pullout might leave the others free to devalue, enhancing their competitiveness.

If the remaining countries are left to secure economic policies more to their liking, a departure would not lead to complete breakup.

Still, a large country leaving would reduce the scale of the euro market, possibly pushing others to reconsider the costs and benefits of losing their own currency, thus leading to a general breakup.

Some have floated the idea of a temporary departure to rebalance Europe's economy.

Edward Hugh, an independent economist based in Barcelona, Spain, said he could imagine Germany stepping out of the currency zone for a few years to allow southern economies to devalue their currencies and restore competitiveness.

"One reading, it could be benign and positive it if was done in an amicable, structured way," he said.

"Spain urgently needs devaluation. ... Greece does, Portugal does. It would be much cleaner to let Germany go out, maybe Holland and Austria go with them, they have a little euro zone for a while. Their currency rises, the others fall. We can begin to export again, bring in tourists, sell properties on the coast," Hugh said.

Yet a breakup would likely not be amicable and orderly, says Daniel Gros of the Center for European Policy Studies in Brussels.

"The markets are so integrated that it would lead to disaster everywhere if you tried to disentangle the euro zone. ... It's like if you take some eggs, make an omelet. You can do that, but you cannot unscramble the omelet."

For instance, German banks would have deposits in strong marks while being faced with other countries paying back debt in weak euros. "They would all go bankrupt," Gros said.

Two leaders

Additionally, Germany and France have been the drivers of a more united Europe. That was the lofty ambition championed in the 1980s and 1990s by Germany's Helmut Kohl and France's Francois Mitterand, leaders of that era. They shared a common vision of using economic unity as a safeguard against tragedy such as World War II.

But in this era where the global economy makes nations interdependent as never before, some have begun to question whether Europe needs such rigid economic ligatures to ensure the continent never again plunges into war.

Anti-euro sentiment still abounds on the street in Germany and is occasionally whipped up by the media. The mass-circulation Bild daily asked on its front pages recently: "Do we need the mark back?" (The answer on page 2: "NO.")

While the government is pro-European, many ordinary Germans still miss their sturdy Deutschemark, a symbol of postwar prosperity.

Still, only 8 percent of Germans polled by the Allensbach Institute last month said they saw any possibility of reintroducing the German mark — even though 47 percent would prefer to have it back, while 41 percent disagreed.

That is actually fewer than a similar survey in 2008, when 56 percent wanted the mark back.

The political wavering over how to shore up sovereign debt for Greece and others only emphasized the euro project's underlying failures: 11 years after the original members locked their exchange rates to usher in the new currency, they lack the coordinated government spending policies that might have secured the euro's future.

Fear of a breakup of the euro may be an incentive to finally fix those founding flaws.

"It is necessary to go further now. We do not cradle any more illusions: A single currency cannot work without solidarity among states," France's Le Monde wrote in a page-one editorial. "Without budget harmonization and without a minimum of economic convergence, the euro cannot exist. And without the euro, Europe doesn't count for much."