This is no time to listen to the siren call of the euro

Since the Labour party entered office in 1997, the UK economy has become more "European". One of the government's first acts in office was to sign up to the EU's social chapter. It followed this with the introduction of a minimum wage in 1999, along with sustained increases in public expenditure. The UK, which in 1997 had one of the smallest states in the EU, now has a larger government sector than Germany or the Netherlands. There has, however, been one area where the gap across the Channel has resolutely failed to narrow: membership of the euro.

For the past five years, the issue has been politically dormant in the UK. But proponents of membership have started to make their voices heard again. The credit crunch, they argue, has revived the case for joining the euro. Various claims are advanced in support of this claim. One is that the UK economy is now so synchronised with the euro area that, as Willem Buiter, professor of European political economy at the LSE, puts it, "the country looks like a suburb of Frankfurt". Another is that the credit crunch has exposed how bad an independent currency is for financial stability. A third is that it has so discredited the "Anglo Saxon" model of capitalism that the UK should rid itself of all its last vestiges the better to consummate its links with the EU.

Eurosceptics have always maintained that economic and monetary union would unravel the moment it was tested by a major economic downturn. The euro area experienced a downturn after the dotcom bubble burst in 2001, but it was fairly shallow and shortlived. The challenge posed by the world's deepest financial crisis since the 1930s will be of a different order altogether. The credit crunch should test conclusively whether it is sustainable for countries to share a single currency outside a political union.

The financial markets seem to be sceptical. The difference (or "spread") between the yields on German government bonds and those of many of the other member states have widened steadily over the course of 2008. In Greece's case, the spread over German bunds is now almost a full percentage point, while in Italy it is 0.9 and Spain 0.6. A year ago, the differences were negligible. What these spreads tell us is that investors have more confidence in the ability of the German government to service its debts than the Italian, Spanish or Greek governments. And since they share the same currency, this means investors believe there is a growing risk that the euro area will unravel.

Why? One reason is the profound macroeconomic imbalances that have emerged in the euro area. Since the launch of the euro, the trade competitiveness of the participating member states has diverged steadily, largely because of exceptional wage restraint in Germany and the Netherlands and extremely weak productivity in countries such as Spain and Italy. As a result, huge current-account deficits have opened in some member states - notably in Spain, Greece and Ireland, and to a lesser extent in France and Italy. These have been offset by huge surpluses in Germany, the Netherlands and Austria. In some cases, such as Italy and Portugal, this lack of underlying competitiveness has been depressing economic growth for years. In other member states, such as Spain, the credit boom masked the underlying problem.

Now that credit boom has come to an end, everything has changed. Unlike the UK, hard-hit countries such as Italy and Spain cannot rely on currency depreciation to help restore their external competitiveness. Within a currency union, adjustment can only occur through wages, or more precisely unit wage costs, not the exchange rate. Even if their labour markets were sufficiently flexible to ensure the necessary decline in real wages, they would still need to undercut German real wages - which are falling. This will make it hard for countries such as Spain and Ireland to rebalance their economies, or for Italy to escape economic stagnation, casting some doubt on the long-term sustainability of their membership.

Another reason why bond markets seem to have shortened the odds on the euro area unravelling has been the EU's chaotic response to the banking crisis. Participants have been unnerved not just by EU countries' belated and, until this weekend at least, ad hoc actions, but also by the apparent willingness of countries to adopt beggar-my-neighbour policies that destabilise other member states. Cooperation between EU countries has, thankfully, improved over the past few days - with euro area countries agreeing on Sunday to copy certain elements of the UK's bail-out plan. But the national bickering that went before reminded the financial markets that the EU is not a unitary state, and that no monetary union has yet survived outside a political union.

It is possible to make a powerful case for Britain joining the eurozone. But the case for joining now, just when the viability of the euro is set to be severely tested, is weak.