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September 25, 2017

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Eurozone elite will do what they must to protect the union

LONDON -- As talk persists that cash-strapped Greece might have to exit the euro, and bond markets panic over Spain, the fate of Europe's single currency could soon be hanging in the balance again.

After "Grexit" and "Spanic," is it finally time to get ready for "Eurover"?

The euro certainly seems in danger of market-driven disintegration, as signaled by wildly divergent borrowing costs among the nations sharing the currency. Bond yields in Spain are at euro-era highs because investor confidence has evaporated, while yields on two-year German notes and 12-month Dutch bills are negative.

Ever-greater economic divergence is assured, scaring investors still further.

But if the currency does break up, it will be for want of political will, not for want of policy solutions.

"Is there some point at which the integrity of the region is sufficiently undermined that we pass the point of no return?" asked David Mackie, an economist with J.P. Morgan in London.

"I don't see that happening in a technical sense, because anything happening in the capital markets at the moment can easily be reversed," Mackie added. "The breakup of the monetary union is not something that can ever be forced by financial markets."

That is because the European Central Bank, like any other central bank, could if necessary expand its balance sheet, or "print money," without limits to contain capital flight or buy up the debt of besieged member states.

Things would be different if the ECB were defending a fixed exchange rate with a finite stock of foreign-currency reserves. That is the position that the central banks of France and Spain found themselves in 19 years ago this month.

Masters of Improvisation

Selling pressure on the French franc and peseta was so intense on July 30, 1993, a Friday, that the central banks threw in the towel, unable to keep their currencies off the floor of the Exchange Rate Mechanism (ERM), the precursor of the euro.

Britain had pulled out of the ERM for good the previous September under speculative attack from George Soros and other investors, while Italy had suspended its membership of the currency grid.

If France were to go the same way as Italy, or even suffer the milder indignity of a devaluation, it would deal a body blow to the Maastricht Treaty on economic and monetary union signed in March 1992. The launch of the euro scheduled for 1999 would be delayed, if not scuppered.

What to do? At a Sunday crisis meeting in Brussels that ended just before dawn, finance ministers emerged with an ingenious compromise: they simply moved the goal posts, widening the ERM's permitted trading bands to 15 percent either side of the grid's central rates, from 2.25 percent before.

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