THERE WAS a time when Kenneth Clarke’s admission that “the euro has been a failure” might have dominated the headlines for weeks. It might even have changed the course of Britain’s history. Had Mr Clarke been prescient enough 15 years ago to recognise the fatal flaws in the single currency project, the Tories might have been spared the humiliation of Black Wednesday and the suicidal infighting over the Maastricht treaty; they might still be governing the country.

If the ex-Chancellor had humbly admitted five years ago that he had been wrong about the euro, he would surely now be the Leader of the Opposition and the Conservatives might be vying for power with Labour in a hung parliament. By this week, however, Mr Clarke’s public confession about the failure of the euro was as irrelevant to the future as Macbeth’s final soliloquy comparing himself to “a walking shadow, a poor player who that struts and frets his hour upon the stage and then is heard no more”.

But while Mr Clarke’s regrets about the euro may no longer be of any interest in Britain, they remind us of something extremely significant about the wider world beyond. The euro has been enjoying a political honeymoon in the four years since it was introduced. While the Europe’s economic performance has gone from bad to worse almost since the day when the euro was launched in January 1999, no respectable politician has ever dared to blame the euro or criticise the single currency project in any way. This taboo has now been lifted.

In Italy, Silvio Berlusconi has consciously encouraged an anti-euro movement designed to blame Italy’s problems on Romano Prodi, the man who took Italy into the single currency, who happens to be his main political opponent in the forthcoming general elections. In the Netherlands, France and Germany, the euro has started to be blamed for inflation, economic instability and unemployment — and while some of these charges may not be intellectually sustainable, nobody can dispute that the European Central Bank has performed poorly, certainly in comparison with the US Federal Reserve Board, the Bank of England, the Bank of Japan or the emasculated German Bundesbank.

Why does all this matter? Because the euro, like any other paper currency, is just an illusion; its power to command people’s lives and motivate effort depends entirely on a suspension of disbelief. People must not only think that these elaborately printed but worthless bits of paper will be exchangeable for valuable goods and services. They must also believe that their intrinsically worthless paper money will continue to be honoured for the indefinite future by the whole world. That belief, in turn, rests ultimately on the faith that the value of paper money will be upheld by a government with the right and the ability to levy taxes on a wealthy nation.

But if the EU is not going to evolve towards a full-scale political union who exactly is going to guarantee the value of the euro? And if the membership of the eurozone is never even going to be equivalent to membership of the EU, with Britain, Sweden, Denmark and other EU countries remaining outside, then why should a government, whether it is Italy or Germany, that finds it inconvenient to use the euro not simply opt out and re-create its own national currency?

The sudden emergence of questions such as this does not necessarily mean that the eurozone will fall apart or even that the euro will completely cease to exist, but it does mean that such possibilities may soon be seriously considered. And if investors ever start to worry about the long-term viability of the single currency project, scenarios for the total collapse of the euro will suddenly come into view.

The most plausible such scenario is Italy withdrawing from the euro, under pressure from mounting unemployment, a weak economy and imploding public finances, exactly the same combination of pressures that forced Italy out of the ERM in 1992. If the possibility of Italian withdrawal were ever taken seriously by the markets, foreign holders of Italy’s €1,500 billion public debt would face enormous losses, since the Italian Government would simply convert its bonds into “new lire” and would legally get away with this conversion.

In fact, such are the financial risks of Italian withdrawal to the European financial system, that the Italian Government may now be in a position to blackmail the European Central Bank into reducing interest rates and devaluing the euro simply by threatening to withdraw. Such an easing by the ECB would actually be a rational response to the present economic problems throughout the eurozone. But this is where a multinational monetary institution would face a fatal problem.

If the ECB were seen as capitulating to Italian blackmail, the euro’s survival would face a new and even more serious threat: a collapse of public confidence in Germany and the Netherlands, where populist politicians would start blaming their countries’ economic problems on the weakness of the ECB. Right-wing German and Dutch politicians might well start demanding a stronger currency — and threaten to leave the euro if the ECB continued to accommodate Italy’s “inflationary” demands.

It is possible to imagine a situation where the Germans and Dutch were demanding a tighter policy to punish Italy while Italians were demanded an easier policy to keep their economy afloat — with both sides threatening to leave the euro if their demands were not met. The game would then really be up for the euro and the ECB.

A break-up of the euro seems highly improbable in the next year or two. But anybody who still believes that such a break-up is impossible should bear in mind the lessons from the break-up of the ERM, the sterling, franc and lira devaluations of the 1960s, the collapse of the dollar-based Bretton Woods system in the early 1970s and the prewar abandonment of the gold standard. In confrontations between politics and financial markets, events can move straight from “impossible” to “inevitable” without ever passing through improbable.

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