The euro-zone has been at or near the top of investors’ worries for years.

When it launched in 1999, it was widely seen as a positive step toward closer union. But politicians didn’t set up a strong enough central bank or financial union to offer financial stability.

In 2008-09, Europe sank into a deep recession after the global financial crisis: Germany’s economy shrank by nearly 6 per cent, its biggest fall since the second world war.

The slump quickly spread to the southern countries – Greece, Italy, Portugal, and Spain – as banks and investors, which had previously been desperate to lend to them, suddenly cut off their funding.

A run on the banks

Forecasters predicted countries would be forced to leave the euro-zone and default on their public debt.

There was panic, which triggered a run on the banks. Initially, Greece was in the eye of the storm. Later, the governments of Italy and Spain looked as if they might struggle to meet their debts.

The German government seriously considering forcing Greece out of the Euro-zone as an example, but the fear of ‘Grexit’ only made things worse.

Eventually Europe came out of the debt crisis after Mario Draghi, the president of the European Central Bank (ECB), said it would do “whatever it takes” to keep the currency together. It started buying billions of euros of government bonds to help tide countries over the crisis.

The pandemic hit

The situation was still fragile when the pandemic reached Europe early this year.

One government after another brought in strict lockdowns and forced non-essential businesses to close. The worst affected were those which were already the most fragile: Italy and Spain.

There were fears the euro-zone wouldn’t survive this new virus-induced blow. Italy and Spain would have to borrow enormous sums because of the collapse in their revenues and the staggering cost of their job subsidy schemes.

This raised the spectre of a new sovereign debt crisis.

It’s true that for a while in March this year, the euro-zone seemed to be teetering on the brink of a new financial crisis. Head of the European Central Bank, Christine Lagarde, hesitated over whether to throw the bank’s massive firepower behind the single currency.

Bond prices fell and borrowing costs rose. Investors worried most about Italy, where the pandemic was raging, and bond yields were rising at an alarming rate.

The euro-zone surprise

But since the middle of March, euro-zone governments have confounded their critics and mounted a strong defence of its currency.

The first and most important step was that the ECB launched a new ‘pandemic’ bond-purchase programme. This was huge by past standards (initially €750 billion, later increased to €1,350 billion) and was much more flexible than previous programmes.

While the pandemic lasts, the ECB has said it can buy unlimited amounts of government bonds from any affected country. It’s also ditched its previous rule that it would buy bonds in proportion to the size of each economy: now it’ll buy whatever’s needed.

This seems quite a technical policy change, but it was also a political revolution. Germany had previously tried to constrain the role of the ECB.

Big step

On top of this, Europe made a unexpectedly large step towards creating fiscal union within the member nations.

The governments of all the EU countries agreed to borrow a large amount (€750 billion) to finance government spending to help countries through the crisis.

This was an even bigger pivot for Germany, because its opposition to fiscal union had been even fiercer than its control of the ECB.

This year’s step towards fiscal union has been widely compared to the moment in 1790 when Alexander Hamilton, now famous as the hero of the Broadway musical, took on the debts of the Thirteen Colonies and created the US treasury bond market.

So, why did Germany take such a different approach?

Firstly, there was no scope to blame particular governments, as happened in 2009’s debt crisis.

Secondly, German Chancellor Angela Merkel was widely praised for how she handled the pandemic at home. Her rising popularity gave her room to push through a pragmatic, pro-European policy with little opposition.

Storm clouds remain

The future for the euro-zone still looks difficult. Like most of the rest of the world, the region has not eradicated the virus. Some parts of the economy have sprung back to life as the lockdown was lifted, but much of it remains barely active.

The fear is that unemployment rate will shoot up as job subsidy schemes are wound down. The outlook for tourism-dependent southern economies is the bleakest.

But at least the threat of a new existential crisis in the euro-zone has passed, for the time being. For a change, the European Union can claim to have had a ‘good crisis’.

One of the founders of the European Union, Jean Monnet, famously commented that Europe would be “forged in crisis”. In 2020, this seems to have been true.