The fate of the euro and the fate of the EU

The euro is plagued by the basic problem that the eurozone does not meet the basic requirements of an "optimal currency area".

Paul Krugman wrote in 2012 (Revenge of the Optimum Currency Area NBER Macroeconomics Annual 2012 Vol. 27) that "right from the beginning" of the euro, economists working with the "theory of optimum currency areas" warned that it "suggested serious concerns about the euro project." He explains:

The disadvantages of a single currency come from loss of flexibility. It’s not just that a currency area is limited to a one-size-fits-all monetary policy; even more important is the loss of a mechanism for adjustment. For it seemed to the creators of optimum currency area (OCA), and continues to seem now, that changes in relative prices and wages are much more easily made via currency depreciation than by renegotiating individual contracts. Iceland achieved a 25 percent fall in wages relative to the European core in one fell swoop, via a fall in the krona. Spain probably needs a comparable adjustment, but that adjustment, if it can happen at all, will require years of grinding wage deflation in the face of high unemployment. [my emphasis]

Recessionary effects hit different regions of a currency zone with disproportionate effects, i.e., "asymmetric shocks." If the currency zone has a common budget, countercyclical measures can be designed that transfer money from the less heavily stricken regions to the ones hardest hit during a recessions. The concept isn't all exotic, though it sometimes sounds so in the economic jargon:

Let’s once again take a not at all hypothetical example: Florida, after the recent housing bust. America may have a small welfare state by European standards, but it is still pretty big, with large spending in particular on Social Security and Medicare — obviously both are a big deal in Florida. These programs are, however, paid for at a national level. What this means is that if Florida suffers an asymmetric adverse shock, it will receive an automatic compensating transfer from the rest of the country: it pays less into the national budget, but this has no impact on the benefits it receives, and may even increase its benefits if they come from programs like unemployment benefits, food stamps, and Medicaid, which expand in the face of economic distress.

This provides not only relief in a humanitarian sense. It also gives harder hit areas additional purchasing power that stimulates the economy in those areas, especially if there is effectively labor mobility. That transfer function makes the dollar currency zone (the US) a "transfer union." The EU is not.

In addition to a transfer union and labor mobility, the ability of the currency zone to borrow money secured by the union as a whole in order to benefit some sections of the currency zone more than others is an important feature to make it workable. In other words, the currency zone needs a lender of last resort. The lack of it in the eurozone was a major factor in the post-2008 euro crisis.

But the EU doesn't have a transfer union, a banking union, a common borrowing capacity (though the ECB has been to partially mitigate that lack), or a common budget. And labor market mobility among EU countries is significantly limited by language as well as different educational systems. Although Krugman notes "lack of labor mobility has not played a major role in euro’s difficulties, at least so far."

(It's worth noting here that a drive through rural states or cities hard hit by de-industrialization will dramatically show that the dollar "transfer union" doesn't entirely eliminate major regional disparities in prosperity.)

Wolfgang Münchau warns in the Financial Times that the unresolved problems of the euro currency zone are more a threat to the survival of the EU than Brexit (Lack of eurozone reform outranks Brexit as the EU’s biggest threat 12/17/2017):

There is a theoretical argument that a fully functioning banking union constitutes a sufficient set of conditions for eurozone stability. It would be a wonderful proposal for a monetary union in a parallel universe. Back on earth, fiscal union is needed precisely because the banking union will always be imperfect.

Therefore, the fundamental problems of the eurozone will remain unaddressed: large and nondecreasing financial imbalances between member states; weak banking systems that are overdependent on EU members; an inbuilt tendency towards pro-cyclical fiscal policies that exacerbate boom and bust; a lack of instruments to deal with asymmetric shocks; and, most important of all, a fundamental lack of trust. The cyclical economic recovery has deflected attention away from these issues, but has not resolved any of them. [my emphasis]

I would add the refugee crisis. It's currently in a less acute phase. But it is both a symptom and the cause of the lack of trust between EU members.