In periods of economic prosperity, a unified ("pegged") currency tends to work fine. The problem of having a unified currency comes in periods of crisis. With an "independent" (floating) currency, when there is a crisis, economic prospects collapse, international investors tend to remove their capital, governments start printing money, central banks often decrease the interest rates, and all of that tends to significantly depreciate the value of the local currency. The depreciation of the local currency makes local goods cheaper in the international market, which can encourage exports, tourism, and other sectors, helping to recover from the crisis. In other words, having an independent currency, i.e. letting the currency’s exchange rate float (be controlled by the markets), can help absorb economic shocks.
However, this not the situation with the euro, a unified currency. All PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain) used the euro during the 2008 Crisis, but they have relatively little say on the monetary policy of the euro. Germany and France are the main voices in the European Central Bank, which is headquartered in Frankfurt. Therefore, the PIIGS could not depreciate their currency to “export” their crisis because their currency is de facto “pegged” in the currencies of the euro core countries, especially Germany. We know from the Mundell-Fleming Trilemma that governments can only choose 2 out of 3 options: pegged exchange rate (i.e. fixed exchange rate), monetary policy autonomy (i.e. the ability to increase or decrease interest rate), and free movement of capital (i.e. absence of capital control). All eurozone countries outside of the EU core are de facto choosing a pegged exchange rate and free movement of capital while giving up on monetary policy autonomy (and the ability to print money). This is a problem when a crisis comes because you cannot enjoy the benefits of floating exchange rates to absorb economic shocks (Stiglitz, 2016). Within the EU, countries that do not have the euro as a currency have been economically outperforming eurozone countries since the implementation of the euro.
How can the euro be fixed?
Robert Mundell (1961) has won a Nobel Prize due to his study of optimum currency areas and has taught us very much about unified currencies. A single currency works best in a highly uniform area because monetary policy affects the whole jurisdiction. For example, if a country is not uniform in a way that one part of the country is in economic crisis and the other not, changes in monetary policy may positively affect one place and negatively affect the other. Ideally, you have a uniform region that suffers the same shocks and booms. This is impossible to happen in Europe since the countries have extremely different economies. The economic crisis will affect some areas more strongly than others. However, there are ways around this problem. Even highly diverse jurisdictions, like the US, have successfully maintained the same currency for centuries. To do so, they have used a fiscal union, i.e. they have major federal taxes and redistribution programs. Moreover, they have easy mobility of labor. Europe has none of these 3 elements.
(1) Massive Redistribution of Wealth. You need a country to have a currency and Europe is not a country. Countries manage to maintain the same currency for centuries because they have the fiscal union. That means, the federal government can to a large extent control each state spending and taxes. However, in Europe, this is impossible because southern Europe will not allow Germans to control their federal tax rates and spending. Southern Europeans will say they are sovereign countries and will not allow a foreign country to control them. In the US, on the other hand, there is a major redistribution of wealth within the country. For example, more than 30% of the general revenue of the poor American states of Louisiana and Mississippi comes from the US federal government (US Census Bureau, 2016). No European country has a general revenue that is more than 2% coming from the EU. In the US, more than 50% of the overall US government spending is made by the federal government (Gruber, 2015). The EU government expenditure represents 1 or 2 % in terms of total government expenditure in European states.
(2) Fiscal Union. Germans and core EU countries will never be willing to spend money with Greece and the EU “periphery” because they do not pay their taxes well. In Greece paying taxes is seen as a stupid people thing, as Nobel Laureate Richard Thaler has pointed out. In Germany and most Germanic language countries, their citizens pay their taxes thoroughly. Therefore, why would Germans want to bail out Greece and the periphery if they do not pay their taxes, if their government spending is constantly greater than the amount of taxes collected, and if Germany and other core countries cannot control their fiscal policies due to national sovereignty? The answer is, Germans will not bail out anyone. If anything, Germans will bail-in these countries, which means that they will let investors take losses. For example, during the 2008 crisis, the EU bail-in Cyprus and consequently their local banks stole money from clients' retirement funds (pension plans). In the US, conversely, all US citizens helped to bailout broken states and companies, such as GM and Chrysler, with relatively little resistance. And the federal government can control how much each citizen in each state pays in taxes through federal taxes and spend, i.e. redistribution of wealth. In Europe, there is no major EU tax (like a European income tax) and no major redistribution of wealth within its member states. As long as this fiscal union does not happen, no country will be willing to bailout anyone. Thus, Europe either needs to become a kind of United States of Europe or at some point, the euro as we know it will likely collapse (Stiglitz, 2016).
(3) Easy mobility of labor. The US has another advantage in comparison to the EU for having another currency: easy mobility of labor. All US states have the same language, very homogenous culture, and pretty much the same companies. Therefore, if there is an oil crisis that affects only Texas the dollar will probably remain strong, which is bad for Texans, but they can easily move to another state. That would happen because even if they only speak English it will be relatively easy to get a job. Texans will also be able to find their favorite coffee shop and clothing store in any other American state. On the other hand, in Europe, even if there are a fiscal union and redistribution, Portuguese people, for example, may not be able to move out during a crisis that affects only Portugal. That would happen because Portuguese people will find it very hard to find a job elsewhere in Europe only speaking Portuguese. Moreover, many other things would be hard, like eating their favorite meal or going to their favorite supermarket. The culture is just too different overall. In other words, the costs of moving in Europe are much higher than in the US. Additionally, basically, no one would be upset in the US if everybody leaves South Dakota. On the other hand, if Portugal becomes a semi-desert, the Portuguese will not be happy at all.
Where we are and where we are going
Currently, the situation of the eurozone is the following. The highly skilled southern Europeans, who tend to speak English and were funded by southern European public schooling and health care, go to the northern countries to work and pay their taxes locally which is not redistributed to the southern countries. In other words, there is a brain drain in Europe going from the Southern countries to the Northern countries and these highly skilled workers are leaving public debt in their home country to be paid by low skill individuals with low salaries who cannot emigrate. The same happens with cash flows. Since Germanic countries are safer for investors and many of them use euro, individuals will much rather put their euro-denominated capital in northern Europe rather than southern Europe, making the rich get richer and the poor get poorer.
In the past, all major currencies were pegged to gold, i.e. the gold standard. In periods of crisis, that the gold standard led to many problems such as deflationary pressures since the monetary base could not be expanded (Eichengreen, 1992). Eventually, the gold standard broke up during a period of crisis and the countries who abandoned it first recovered faster. As well as the gold standard, the most likely scenario is that at some point the European countries will prefer to break the euro and reintroduce their own currencies. However, the costs of such breakup will probably be enormous. For example, eurozone companies (like Fiat in Italy) get loans by selling bonds denominated in euros. If Italy leaves the euro, its currency will be much weaker than the euro. Therefore, Italian companies will have loans denominated in euros but revenues in the lira. Corporate euro-denominated bonds are usually issued in Luxembourg and London and their currency denomination cannot be changed later. Consequently, many companies will suffer huge losses and many will go bankrupt. This “experiment” has been done in a country called Argentina. In 1991, Argentina decided to peg its currency (peso) to the dollar to fight inflation (much like the initial idea of the euro). When an economic crisis arrived, however, they decided to break this peg so that a floating currency could absorb the economic shock as explained in the first paragraph. Within months, the peso lost 75% of its value against the dollar. Consequently, Argentinian companies had liabilities four times larger than they had before and the same revenue. The Argentinian economy entered in complete collapse, including default on foreign investors, unemployment rate greater than 20%, and the monthly inflation rate was 20% by April 2002. Between 1998 and 2002, the economy shrank about 30% in the episode known as the Argentinian Great Depression. Therefore, eurozone countries are highly unlikely to break the euro unless the situation is dramatic, which might happen in a major crisis much like Argentina in 2001 and the collapse of the gold standard.