In a couple of articles in these columns, I had written that the worst of the global depression was behind us. Like many others, I too mentioned that the “green shoots of recovery” were evident on both sides of the Atlantic. In particular, both the French and German economies — the two largest in Europe — registered positive rates of growth during the last quarter of the previous year, generating hopes that other European countries would soon catch up with the leaders, while both unemployment and national income data showed that the recession was bottoming out in the United States of America.

Unfortunately, the recent crisis in Greece that threatens to engulf all countries using the euro as the common currency suggests that the earlier predictions of a quick recovery from the global downturn may have been unduly optimistic. As most readers of The Telegraph probably know, past sins of omission and commission have caught up with the Greek government. The previous government cooked its books to hide the massive size of the public debt. The problem was compounded by the inability or unwillingness of the current government to enforce the draconian austerity measures required to redress the situation. Of course, matters were not helped by the fact that the stagnation in the economy has meant a corresponding stagnation in government revenues. The net result is that the Greek economy is now dangerously close to collapse — it will default on its sovereign debt unless it receives massive bailouts from the European Union and the International Monetary Fund.

The Eurozone finance ministers have just decided to extend an emergency aid package worth $146 billion. In addition, the Greek government has raised tax rates and imposed other very severe austerity measures, including a 10 per cent salary cut for government officials. These measures have generated a lot of public unrest in the country, including a 48-hour strike by civil servants. (The strike may actually be welcomed by many who feel that the less one sees of the Greek bureaucracy, the better it is.) However, there are fears that the size of the bailout package is too small, and at least one prominent European politician has already gone on record to claim that Greece will have to borrow more money within 18 months.

A greater cause for concern is the apprehension that the contagion (of insolvency) will spread to some of the weaker European countries such as Spain, Portugal and Ireland. This would turn out to be very costly for other economies in Europe for at least two reasons. First, the countries that are immediately affected by the threat of rising public debts will be forced to deflate their economies. This, in turn, means that they would represent ever smaller markets for other countries’ exports. Second, the two giants of Europe — Germany and France — will have to use up a non-negligible fraction of their own resources in order to shore up the economies of the weaker countries. For instance, Germany has agreed to contribute as much as a fifth of the current bailout package for Greece. The two countries could have utilized these resources to stimulate their own economies.

The governments in some of the weaker European countries have started to take corrective measures, essentially in the form of tightening belts. Real wage cuts have been enforced in Ireland. In Spain, the prime minister has announced that workers would have to increase the number of years over which they make contributions before they are eligible to draw state pensions. Not surprisingly, this has alienated trade unions in Spain.

Of course, the public opposition to any kind of austerity measure acts as a constraint on the set of policies which beleaguered governments can implement in order to avoid the stigma of defaulting on sovereign debts. However, there is an increasing convergence of views that the more serious constraint affecting Greece today is the use of the euro as a single currency. The European love affair towards monetary union has implied that individual countries can no longer adopt independent monetary policies. So, the “usual” remedy of devaluing the national currency is no longer a feasible option. A devaluation of the earlier Greek drachma would have meant that Greek exports would have been cheaper abroad since the costs of all domestic inputs such as labour would have been lower in terms of the international currency. The real cost of servicing all debts denominated in the local currency would also have been lower.

The inability to adjust exchange rates means that the entire burden of tackling the mounting sovereign debt falls on fiscal policy — essentially the type of austerity measures that Greece has implemented. Perhaps the consequences of fiscal contraction would not have been so painful if the short-term prospects for the Greek economy were not so dismal. Unfortunately, the prospects of the Greek economy growing out of trouble are pretty remote. One estimate suggests that Greece’s real gross domestic product will not reach its 2008 level until 2017, and even the Greek prime minister has recently stated that the ratio of public debt to GDP will continue to grow until 2013.

A natural question that arises is whether the benefits associated with the single currency system have exceeded the costs. It is certainly true that the formation of the European Union has generated significant trade benefits to the member countries. But, it is not clear whether the same trade benefits could not have been achieved without monetary union. After all, the member countries could have abolished all inter-country taxes within the European Union while maintaining their individual national currencies.

There has been a somewhat cynical suggestion that the real reason for the formation of the single currency union lies in the political sphere. The hypothesis is that Germany and France wanted to form a giant ‘Europe’ with them as the joint leaders in order to combat the hegemony of America, and assert their own position as countries which matter in the world order. In order to further this objective, they had to put in place the main characteristics associated with the notion of a nation state. And how can you have a ‘nation’ without a ‘national’ currency? Thus was born the euro.

Will the recent crisis result in a break-up of the single currency system? The situation in Greece has deteriorated so much that it is in no position to pull itself out of the mess on its own, and will not receive any help from the rest of Europe if it were to leave the system. On the other hand, Germany and France will not want to break up the system either, unless the basket cases require a continuous infusion of resources. But the Greek crisis should serve as a warning to other regional groups which may contemplate unions based on the European model.