The Euro’s Weak Heart Threatens its Survival

The three largest economies in the Euro are all going nowhere fast. Their declining prospects reflect their deep structural issues. They also symbolise the fragility of a Eurozone which has failed to significantly strengthen its institutional architecture over the past decade.

Quite predictably– the Euro, once again, is hopelessly exposed to domestic financial crises.

All the furore in Brussels about improving EU competitiveness is predicated on a stable currency union. Unfortunately, this assumption will be tested by the financial markets in the months ahead.

And this time it’s the very heart of the EU – France, Italy and Germany – that pose the biggest threats to the Euro’s very survival.

France presents the most immediate problem with a current budget deficit of over 6% projected for 2024. The proposed French budget for 2025 – despite significant tax rises and spending cuts – only envisages Paris reaching the 3% Maastricht criterion by 2029.  And even the achievability of this target has been met with scepticism by many economists. With public spending at 58% of GDP and an expanding debt pile approaching 120% of GDP – France is finally facing an economic reckoning decades in the making (Paris hasn’t run a budget surplus since 1974).

The fragility of the Barnier government compounds the nervousness of the financial markets. It now costs France more to borrow money on the financial markets than either Spain or Greece. French bonds are already priced as part of the “euro periphery”. As the Eurozone’s second largest economy the implications of a French financial crisis for the Euro are obvious. As highlighted by the Martens Centre in May 2024, France and Greece are now trending in exactly opposite directions when it comes to debt sustainability.

Similarly, Italy has failed to break out of its low growth, high debt economic cycle. The latest data from the Bank of Italy projects growth of just 0.6% in 2024. The European Commission estimates that its debt will exceed 140% of GDP in 2025. To plug current budget gaps, the Italian government is planning on imposing additional taxes on banks and insurers. Like France, this is not a coherent plan for the public finances, but rather an annual exercise in crisis management.

Germany – despite a very healthy debt to GDP position – is now experiencing the result of decades of underinvestment across key economic sectors. A domestic policy position that is now compounded by an economic model rendered partially obsolete by strategic decisions in Moscow and Beijing.  Germany’s current recession may be the harbinger of a truly painful (and lengthy) economic readjustment to come. One that will reverberate throughout Central and Eastern Europe given the integrated nature of supply chains in this region, particularly in automotive production.

The reality of this low growth model is that the Eurozone remains susceptible to a potential French or Italian financial crisis in the short term. A crisis likely sparked by future political instability.

So, while Brussels debates Draghi’s longer term proposals – or the marginal recent revision of the EU’s fiscal rules – the foundations underpinning the Eurozone’s fragility go unaddressed. 

Namely – in an unfinished monetary union where the ECB acts as a buyer of last resort for Italian and French debt – there will never be sufficient political ownership to undertake the required national reforms. We shouldn’t forget that the structural impediments to faster growth in both France and Italy – lack of competition in key sectors, unsustainable social security models, local and national level bureaucracy, poorly targeted public spending – are domestic level issues requiring domestic level solutions. 

True competitiveness can’t be imposed in a top-down manner on national economies.

France and Italy are only a Eurozone problem due to the possible contagion effects in a partially built monetary union. And because the EU – in ignoring its own “no bailout” rule during the Great Financial Crisis – has de facto embedded “bailouts” into the Eurozone’s institutional structure. So while Draghi may have saved the Euro in 2012, his institutionalisation of the ECB as the ultimate arbiter of national borrowing yields (in effect capping yields by buying available debt) has disempowered national policymakers. It has also ensured the survival of the low growth, high debt model evident in France and Italy over the past decade.

But all is not yet lost. An overarching EU focus on competitiveness, empowering SMEs and reducing bureaucracy should be matched by structural reforms at national level to create a new momentum for action. Returning to the Lisbon Agenda of the 2000s should put the focus on a deepening Single Market as the driver of higher economic growth. EU funding must act as a catalyst for reform at national level, not just a top-up for national budgets. And, perhaps most importantly of all, the EU and member states must stop talking about completing a Banking and Capital Markets Union – and actually deliver. This time, the future of the Eurozone may be at stake.