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The biggest threat to the euro will not be countries such as Greece choosing to set-up a new currency but French and German citizens deciding they are not happy with a single currency, says Karl Whelan.

In the years prior to the current period of crisis and recession, academic economists and legal experts would sometimes debate whether the euro was really an irrevocable arrangement or whether it could end due to some countries choosing to leave.

At the time, this seemed a somewhat ivory-tower debate but the issue has become a major news story this year.

For what it's worth, the ivory-tower guys generally concluded that it was very unlikely that any euro-area government would choose to leave the common currency.

The issuance of a new currency cannot be done overnight. If the intention is to immediately devalue the new currency, such a plan would trigger an immediate run on banks as depositors would look to move their euro-denominated deposits to other countries, a run that would be hard to stem due to EU rules on free movement of capital.

 Indeed, under some legal interpretations, a country's exit from the euro would require them to leave the EU altogether because a commitment to euro participation under the right conditions is a legal obligation of EU members.

Leading US economist Paul Krugman has recently argued that while he always considered exit of a country from the euro unlikely, he now thinks it could happen because a country already experiencing crisis conditions may have less to lose from taking the momentous decision to leave the euro. The consensus remains, however, that most governments in the middle of a sovereign-debt crisis would not choose to add additional problems and further stoke up uncertainty by leaving the common currency at that time.

Even if a country such as Greece decided to leave the euro, this would have limited implications for the functioning of the single currency. Greece joined the euro in 2001, two years after its launch. So the single currency has existed before without Greece and could do so again without it or a number of other member countries. 

Despite this consensus among academics and many in policy circles that the threat to the single currency is limited, the idea that a sovereign default within the euro zone will equate to the end of the euro has dominated the media debate.

 This has been fuelled by politicians who should, or perhaps do, know better.  Merkel, Sarkozy and others have sold the €750bn bailout package to the European public in emotive terms such as "saving the euro".

I suspect this may be because the real reasons for the package-protecting French and German banks from the consequences of a default on Greek and other sovereign debt-are less likely to appeal. "Saving French banks (again)" is unlikely to work as a pan-European slogan.

As to whether the package has, in fact, reduced the likelihood of a breakup of the euro zone, I think it's too early to tell.

On the positive side, countries that have lost the devaluation tool as a response to the fiscal crisis have now been given a form of support during a crisis over and above what the IMF would be able to provide to European countries.

 If this avoids the scenario in which euro membership is associated in the public's mind with the dislocations associated with sovereign default, then this may put less pressure on governments to leave the euro in the event of severe fiscal problems.

However, one can also point to negative implications. Countries that avail of the EU Stabilisation Fund will have to enforce severe budgetary adjustments. One might argue that, by definition, these adjustments would be required in the absence of a bailout fund. However, it is likely that the EU (and hence the euro) will get assigned much of the blame for the pain associated with these adjustment plans. 

That the existence of the bailout fund will imply a substantially increased role for the European Commission in budgetary formulation in euro zone countries is an inevitable consequence of the existence of the stabilisation mechanism.

This development may be welcome in light of the poor budgetary management in many of these countries in recent years. However, the Commission's role in the budgetary process will be resented by some citizens as undemocratic and will be cited regularly by eurosceptic groups as a reason to leave the euro.

The bailout fund has been sold as a gesture of cross-country solidarity across the euro zone. However, the truth is that the benefits of this approach are not evenly spread. Some countries are more likely to avail of the fund than others.

 In addition, because some countries have banks that are clearly more exposed to the debt, a fund to pay off this debt will disproportionately benefit those countries, most likely saving them from further expensive and unpopular banking-system bailouts. The realisation that the benefits of the stabilisation mechanism are unequally distributed may have negative political consequences in the future.

Over the longer term, the biggest threat to the euro will not come from countries such as Greece choosing to establish a new currency. The biggest threat will come from citizens, and ultimately politicians, in a large EU country such as France or Germany deciding that they are not happy with the single currency.

One scenario that could lead to such an outcome would be if membership of the single currency became associated in the minds of citizens of these countries with repeated bailouts of less disciplined peripheral members.

While this is not a likely scenario over the coming few years, I suspect that the announcement of the new stabilisation mechanism has pushed Europe a bit closer to this outcome becoming a reality.

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