The fundamental problem with the euro is that two main groups with divergent needs share one currency and monetary policy. This problem causes trade and investment imbalances.
This can be seen clearly in the investment practices of Northern tier investment managers. The debt of the periphery is just too risky for them to include in their clients’ portfolios. No matter what the yield, principal preservation seems to be the most important objective of these large institutional investors.
The PIIGS compete with the Germany, the Netherlands, Finland and Austria for investment money because they all share the same currency. Just like they are losing the battle of trade in goods and services because they have relatively unproductive economies, they are also losing the battle for investment euros due to their higher risk profiles.
Each of the PIIGS comes with heightened default risk, whether de jure or de facto. Investment managers are taking this into account leaving the PIIGS sovereign debt markets in droves. This has resulted in higher yields, which being kept artificially low by jawboning and money printing. These lower yields do not reflect the risk of holding PIIGS debt, so foreigners are abstaining.
Cram downs on Greek bondholders and seniority for the ECB have added to the legal uncertainty in holding periphery debt. Corporations are bound by covenants in the bond agreements, but sovereigns can change the rules at will, and Europe has proven that when pushed it will.
Whether Europe likes it or not, the currency union has already cleaved into two, a core of countries where it is safe to keep one’s money and the periphery where it is not.
ECB and EU policies have kept this union together, but at the cost of depressions in Greece and Spain and recession in the rest of the periphery. As political resentment builds, it is only a matter of time before one of these countries decides to leave the euro.