The euro was sold as a symbol of Europe's strength and as something that might one day rival the U.S. dollar for the title of world's reserve currency. It's turned out to be neither. True, Europe's leaders remain committed to their great experiment with monetary union, and for that reason, any talk that the euro zone will soon collapse a standard prediction among U.S. economists is likely to prove off the mark. But to make the euro what it was supposed to be, Europe will have to endure a painful period of economic reform. Over the past few months, we've learned that however politically united the continent might be, the euro is only as strong as Europe's weakest parts.
As that reality has sunk into the minds of investors, the euro has sunk with it. In mid-May, the euro touched a four-year low against the dollar. For Europe, that's probably a good thing. A cheaper euro makes European products more competitive in world markets, which could boost exports and growth in a region experiencing an especially tepid recovery from the Great Recession.
But a weak euro is bad news for the U.S., which was counting on exports to create jobs and sustain its own recovery; in international markets, U.S.-made goods will now be less competitive than European ones. Western Europe, one of the richest places on earth, has traditionally sucked up oodles of imports, but the weak euro will raise their price, depressing demand and with it the chances for a rapid global economic rebound.
Don't expect the euro to reverse course anytime soon. European leaders have failed miserably to shore it up in a timely fashion, even with dramatic displays of resolve. The present crisis was tipped off by investor concerns that Greece might default on its load of sovereign debt, which in turn focused attention on other indebted euro-zone members Portugal, Ireland, Italy and Spain, which with Greece make up the so-called PIIGS. Fears raged about a domino-like series of debt defaults that would cast Europe back into recession.
At least for now, the European Union has effectively squashed contagion by agreeing to assemble a rescue fund for indebted members of nearly $1 trillion. The euro, however, barely took a breath before continuing its slow descent. Why? Because the big fund doesn't solve any of Europe's underlying problems. The debt is still there, and the PIIGS are going to have to deal with it, whatever theoretical money their richer neighbors might have pledged. The PIIGS are destined for radical fiscal surgery to bring down deficits and stabilize debt levels, and that process will further suppress growth. Even with austerity measures in place, there is no guarantee that debt crises can be averted. Greece's economy is so severely messed up that most analysts expect that the country will still require a debt restructuring down the road.
The crisis has also shed light on flaws deep in the very structure of the euro zone. The fact that fiscal irresponsibility in a handful of members nearly brought the entire project to its knees has shown the need for economic policing of member states. There's talk of something like an "economic government" to coordinate individual countries' budgets. In mid-May, the European Commission, the E.U.'s executive body, proposed an advance-review process for budgets. But few of Europe's governments are likely to be keen on handing over more sovereignty to the bureaucrats in Brussels.
More fundamentally, the euro zone has to address the great disparities in competitiveness among member economies, which range from economic powerhouses like Germany and France to basket cases like Greece. That will entail difficult structural reforms in countries like Spain, where labor laws have long featherbedded older workers while leaving a host of younger ones trapped in temporary jobs to weather economic storms unaided. But repairing inflexible and distorted labor markets will not be a political cakewalk, as the furious response by Greece's public-service sector has grimly demonstrated.
Perhaps Europe can manage all of this drastic change in the coming years, setting its currency on a healthier course. Until then, the world might just have to get used to a weaker euro. The research firm Capital Economics predicts that the euro will reach par with the U.S. dollar by the end of next year, falling from $1.24 per euro in the middle of this month a further 20% depreciation against the greenback. The fact is, Europe deserves a weaker currency. Problem is, the rest of the world doesn't.