Defying much commentary that the European single currency will suffer lasting damage from government debt default dangers, Western Asset Management argues that the euro will emerge from the current eurozone crisis stronger than ever. 

While some European countries may have no choice but to restructure their debt, this ominous event will not lead to a collapse in the euro, says Michael Story, economist at Western Asset. In fact, the euro will go from strength to strength in coming years to cement its position as a leading currency, he says.

Western Asset Management is a subsidiary of Legg Mason, the US-listed asset management firm.

Story suggests the euro could become “a global reserve currency” as demand to become part of the eurozone increases, fuelled by former Soviet-controlled states. “For the smaller economies on the outskirts of Europe, the euro represents the destination of a long journey from an anachronistic command economy to a modern free-market democracy,” adds Story, while pointing out that Estonia became a member of the euro this year and Latvia, Lithuania and Poland all plan on doing so by 2015.

It has been proposed by some industry experts that for crisis-stricken members of the eurozone, Greece in particular, withdrawal from the euro would be the best course of action. However Story believes that for a member-nation to do this would be counterproductive, and taking Greece as an example, says it would lead to currency devaluation and set in motion a sequence of events which would end with Greece being much worse off.

“In the end, the only solution would be for Greece to restrict deposit withdrawals, seal its borders, impose absolute capital controls and suspend operation of the bond market – actions that would likely be equally unpopular and far more damaging to the Greek economy than remaining inside the euro area,” says Story. This is why Greece will restructure its debt rather than withdraw from the euro, he says.

Advocates of this view will agree with Story when he infers that the major member-nations will be highly unlikely to leave the euro if the fringe countries are unwilling to do so. The Western Asset economist highlights Germany as an example, stating that joining the euro significantly boosted Germany’s export sector, which has in turn contributed greatly to Germany’s financial stability.

The shared currency has very much strengthened the eurozone as a whole, bringing greater trade openness and financial market integration, as well as improvements to the labour market and a convergence in inflation rates, says Story.

While he commends the European leaders on taking significant measures in a short time span, Story is of the belief that there is much more work to be done, in both a political capacity as well as in monetary policy terms. “The European Central Bank’s decision to begin a tightening cycle now may prove to be the first such error. Such tightening may be correct based on a reading of the economic variables alone, but it is eroding what is left of the eurozone’s political legitimacy, the ultimate determinant of euro survival, just as political legitimacy was key to the fate of the gold standard,” he concludes.