TRADING PLACES: Traders work the floor of the New York Stock Exchange (NYSE) on May 10. Major stock indexes of the NYSE recorded their sharpest daily increase in a year that day following the EU's adoption of a 750-billion-euro rescue package in wake of the Greek financial crisis (SHEN HONG)

If investors remain unconvinced and shy away from further involvement in the financing of the high risk European markets, leaving the ESM to finance rollovers of debt and annual budgets, then the 750 billion euros currently earmarked may run out by 2013. If Italy is also dragged into the investor strike, the ESM might last little more than a year. In fact, if such a widespread bailout began to unfold over the next six to 12 months, with little sign of improvement in the problem countries and euro zone governance, then confidence would evaporate before the ESM's money ran out. The euro zone has little time left to be convincing, at least in its current form.

The stark alternative to making the euro zone function better, if all efforts fail, is to plan an alternative future. It would be wise to consider this backstop. This may possibly involve the creation of an exit strategy, a living will, for countries that cannot meet euro zone membership conditions or even consideration of the break up of the currency union.

Future options

Some see Greece being forced to exit the euro—setting up a new drachma and letting this devalue against the euro to boost competitiveness. The three-year aid package buys time for this to be a feasible option, as estimates suggest that exit could take around two years. But this poses three problems. First, Greece performed poorly prior to euro zone entry—devaluations did not resolve its economic problems before and almost certainly will not now—so structural and governance issues must be tackled instead and in principle this could be done from within the euro zone. Second, other countries might be forced to leave as well, depending on the criteria set for demotion from the euro. And third, it is hard for weak countries to leave the shelter of the euro: Apart from this taking time, such a move would probably send interest rates soaring, preventing access to financial markets and creating an even deeper, longer recession. This might correct an external trade deficit, chiefly by cutting imports, and reduce external borrowing but the turbulence in the economy would be harsh—as typically happens in an emerging market crisis, domestic demand may fall by 20-30 percent while GDP could drop by as much as 10-15 percent.

It is worth reflecting on the fact that it is easier for strong economies to leave the union than weak members. This suggests that one option for the euro zone that must be taken seriously is that it could break apart into a "strong euro" group of economies and a "euro-lite" area that could devalue if necessary to improve competitiveness and encourage economic adjustment.

Most certainly it is time for some serious rethinking of the euro zone, and the next few years will be make or break time. The club rules have to be realistic and strongly enforced but a new regime must include smarter economic analysis as well as tougher policing and penalties if it is to work well. And new ideas for the way forward will have to be considered. Euro zone governments might not like financial markets but they cannot ignore them. As European Central Bank head Jean-Claude Trichet has been reported as saying recently, it is member states' governments, not markets, which have brought the euro zone and the euro to this critical juncture. This already hints at the likelihood of more fractious relations across the euro zone and the probability of contentious new steps being taken.

The view from abroad

Finally, it is important to consider how this European debt crisis will impact opinion, not just within the euro zone but around the world. And how do other countries view the situation and how might they react? Key relationships may be affected.

Firstly, to most observers, this crisis will appear both complicated and a failure for the euro zone. The protracted negotiations before the Greek bailout were already damaging for confidence but the problems that followed were even more troubling, including what some may see as the Europeans using their dominant position to charge part of the EMS bailout fund to the IMF, imposing costs on other countries outside of Europe. This may have repercussions.

Secondly, within the international monetary system, holdings in the euro are probably falling, with money moving into the obvious alternative, the dollar, which a short while ago was out of favor. Such swings in sentiment will serve to accelerate efforts to diversify foreign exchange holdings and create more reserve currencies. The anticipated greater role for Asia, specifically the renminbi (yuan), may be pushed forward.

Thirdly, there may be a shake up of alliances within Europe. Among the new EU member states, Poland has adopted the view that euro membership may not be such a good idea. Certainly there is likely to be a wait-and-see approach given the current situation and the potential for euro zone members to have to pay an ever-larger bailout bill. The group of EU countries outside of the euro will consolidate to watch over their mutual interests while within the euro area, countries may split into a faction chiefly concerned with applying fiscal vigor and the euro rules and another keen to use the crisis as an opportunity to press for further EU integration. There are at least these three important groups centered broadly around the UK, Germany and France—each with different views and agendas. There is likely to be a difficult and contentious period ahead for Europe.

In addition to this, the euro zone crisis has highlighted the need for countries around the world to rein in high budget deficits and debt—most especially those dependent on foreign investors. This includes the United States, although it is currently benefiting from the flight from the euro. Deleveraging must continue and will depress the growth outlook. The aftermath of the global recession and efforts to combat this will continue and, in one way or another, taxpayers everywhere will not be free of the costs of the war on recession for some years to come.

The author is a senior research fellow of international economics at the London-based Royal Institute of International Affairs

(Viewpoints in this article do not necessarily represent those of Beijing Review)