The eurozone: should I stay or should I go?

We took a survey around Eurasia Group a few days ago that posed the following questions:

1) Do you believe that at least one country will drop the euro in the next two years?

2) Do you believe that at least one country will drop the euro before three new countries sign on?

The responses reconfirmed my own view. Less than 20 percent said they believed a country will leave the euro in the next two years. Less than 10 percent believe a country will leave before three new members join. Our senior Europe analysts feel the risk that a country will leave the euro in the next two years now stands at no more than 5 percent.

Why are we so skeptical? With all the debt downgrades and growing economic and policy asymmetries in Europe, there’s certainly been plenty of talk lately about the continued viability of the currency union.

We don’t see much of a threat here because there really isn’t a political grouping anywhere in the eurozone that is both willing and able to execute such a move. And despite the fringe advocacy from hardened Euroskeptics, who are responsible for a lot of the recent noise, governments have important incentives to stay. There’s a growing fiscal divergence within the eurozone that allows them to spend more money on projects that can both boost their political popularity and support key firms. That flexibility eases the burdens that members accept when they surrender control of monetary policy to the European Central Bank (the primary political argument in favor of exit). In addition, policymakers in the most vulnerable European countries, like Greece, understand that eurozone membership lowers borrowing costs — which is particularly important at the moment, given everyone’s liquidity concerns, and especially for countries that are least able to establish a credible independent currency.

For the near term, the eurozone is more likely to add members than to lose them. In Eastern Europe, as governments realize how exposed their populations and leading companies are to foreign-exchange denominated lending, the political will necessary for enactment of the reforms needed to meet the Maastricht criteria, which must be satisfied before they can join the euro, is growing.

In addition, support for expansion is growing among existing member states and the European commission, in part because they see a chance to increase their political leverage with the governments of applicant states. The entry criteria are unlikely to be compromised to speed expansion, but the probability is rising that the politics will come together for the rules to be met.

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