The Future of the Euro (Part VI)

As readers of this blog know, I have been following the debate on whether the Euro can survive the current economic crisis. Most recently, I noted that this crisis may actually lay the foundation for a real fiscal transfer mechanism in the Euro area, something that is sorely needed to make this currency union a true optimum currency area. Such a development, of course, presumes the current economic crisis makes the Euro-area institutions stronger rather than tearing the region apart. The latest news coming out of out Europe suggest the big fear now is that the financial meltdown in Eastern Europe is making the latter scenario more likely. The Europeans are concerned enough about this development that they have called for an emergency summit. Even the typically Euro-sanguine Wolgang Munchau of the FT is concerned that the "Eastern crisis...could wreck the Eurozone." Back here in the United States the mood is equally gloomy according to this article in Bloomberg:

Feb. 27 (Bloomberg) -- Hayman Advisors LP, the firm that earned $500 million betting on the U.S. subprime mortgage-market collapse, says Europe’s monetary union is about to fall apart.

Richard Howard, a managing director for global markets at Dallas-based Hayman, said Germany may opt to shore up its own economy, Europe’s biggest, rather than bail out fellow euro nations such as Austria, Italy and Spain as their banks sag under the weight of bad debts. That might lead to defaults and compel Germany to renounce the euro, he said.

“People said subprime could never blow up but it did and now they’re saying the exact same thing about the eurozone,” said Howard. “There’s no stopping what is now a downward spiral.” He declined to discuss his investments.

Hayman joins a growing number of investors seeing the possibility of a breakup of the $12 trillion euro bloc, conceived more than 10 years ago to cut unemployment, tame inflation and create a rival to the dollar. Societe Generale SA said this week Germany may refuse a bailout in an election year. ABN Amro Holding NV said Feb. 17 the crisis is “Europe’s subprime.”

[...]

The breakup may occur as investors shun all but the safest government bonds, said Hayman, which in 2006 was among the first to bet against Wall Street’s rush to securitize the debt of the least creditworthy U.S. borrowers, correctly predicting a slump in home values that sparked the global credit crisis.

Investor demand for the lowest-risk securities already drove the difference in yield, or spread, between Greek, Austrian and Spanish 10-year bonds and German bunds, Europe’s benchmark government securities, to the widest since the euro’s debut.

So a "growing number of investors" are seeing a greater likelihood of the Eurozone breaking up. If so, you would think these investors would be adjusting their portfolios accordingly. There is an intrade contract that indicates the probability of a nation dropping its use of the Euro by December 31, 2010 has not change much since July 2008 (see figure below). This contract suggests that a "growing number of investors" may be a bit of an overstatement. Or maybe this contract is to thinly traded to truly reflect the increased fear about the Eurozone. Any thoughts?