The Euro Crisis

The European Sovereign debt crisis is yet another serious crisis after the financial crisis that is threatening the European Union countries and the whole world. The euro crisis like the US crisis actually started long time before but the European Union countries felt the pinch soon after the global financial crisis. The euro crisis is a result of various factors not a single factor as is the case with the US financial crisis. The Europe is a large continent that has been in power for a long time since the World War II. The Eurozone consists of twenty seven member states. The crisis started at a time when the world was entering into the timeframe of globalization. As is the case with the US crisis, the euro crisis started from the beginning of the 21^st century. The primary reason for the current Eurozone crisis is mismanagement in government fiscal policies. The whole world is facing the dose of the crisis as the world now has become even more global and complex. So no country be it advanced or emerging is spared from the Euro crisis which is now paving way for a next serious economic crisis of all time.

The European sovereign debt crisis is simply the inability of the government of European Union countries to pay off or refinance their public debt. It all started when the member states of EU forgot the treaty they once signed and agreed in 1992. According to the treaty the member states in Euro area agreed to limit their deficit spending and debt levels. Some countries in the euro area experienced high growth post the world war. Countries like Germany and France faced hyperinflation in 1970s. These were some of the important indicators in EU history that urged their governments to go for a drastic government spending to boost growth. This policy suit over the years has resulted in huge debt levels. The essence of which is now growing like an epidemic in Eurozone area where country after country is following the line of serious breakdown.  The first country to feel the crisis was Portugal later joined Greece, Italy, Ireland and Spain what came to be known as PIIGS. This crisis is something new to the advanced countries as they never really experienced such a serious debt crisis since the industrial revolution in 1760. The degree of risks associated with the crisis varies to each country but all are travelling on the same boat that is about to sink. Although these five countries were seen as being the countries in immediate danger of default, the crisis has serious consequences that extended beyond their borders.

The most surprising part to be noted here is that this huge level of debts was because of high government spending and subsidies with not an equal amount of increase in government revenue that resulted in high economic growth in the last decade. Then why aren’t they able to repay their debt? The answer is very simple they created alarming levels of debt but not that high growth to repay the debt. The debt to GDP ratio was continuously increasing. The European Union countries did not generate enough economic growth to pay their loans. So to what the government happily spent actually did not help but later only resulted in slower economic growth causing a serious economic collapse. This how surprising economic policy is all about. You just cant predict the exact outcome of an event. But with careful analysis you can formulate right policies that can be fruitful. When growth slows as is the current situation not only in EU but in almost all countries so does tax revenues resulting in high budget deficit becoming unsustainable.  The countries like Greece first initially tried to act as if there was no problem with their economy and hide the debt situation for a very long time but in late 2008 the debts was so large that they actually exceeded the size of the nation’s entire economy so that they could no longer hide the problem. As a result of which people started to protest on streets demanding rights. Investors in Greece demanded higher yields on government bonds which raised the country’s burden and necessitated a series of bailout packages by European Central Bank (ECB) and also IMF. In late 2009 the fear of sovereign debt crisis developed among investors as a result of rising private and government debt levels together with a wave of downgrading of government debt in European states by the credit rating agencies.

The European crisis is a result of a combination of complex factors. But all these factors resulted in one single problem, that is huge debt. So now keeping other factors that contributed to the crisis such as globalization of finance, easy credit availability, high levels of private debts, troubled banking system etc aside lets look at the outcome that we face out of all these factors. Debt level is generally related to Current Account Deficit (CAD) and Current Account Surplus (CAS). CAD is where imports are more than exports and the CAS is just the opposite where exports of a country are more than the imports. Apparently the CAD results in less foreign cash inflows and CAS attracts large cash inflows to finance their debt. Government spending is categorized into discretionary that involves defense and others and non-discretionary spending that involves medicare and social security. Government expenditure is also met through debt services like principal and interest payments by the borrowers. One of the primary insights discovered after the euro crisis is that EU countries faced a huge mismatch between their government revenue and spending. To keep this imbalance in track the government not only raises the tax to generate revenue but also sells bonds and treasury bills which are bought by large financial institutions. This is associated with a concept called the Fractional Reserve System according to which more money comes into the financial system that in turn creates new money in circulation in the market which causes an inflationary pressure on the long run. The money in the banking system affects the financial market and credit system. When the money is more and the banking system in general is healthy it amasses huge amount of money and has stronger ability to give loans but on the other hand when the money is low and the system is unhealthy the ability to make loans becomes less. This is the reason why the banking system and the financial market together are so volatile. The inability of the banks to make loans to business affects economic growth on the broader economy. The banks sometime borrow money from the central bank when they have less credit to keep their business going. They keep their government bonds and other assets as collateral and get money from the central bank out of thin air. A small move in the interest rate can cause a crisis. The increase in the interest rates can make the government bonds costlier and worthless. A slight increase in the interest rate causes a great mismatch between government spending and revenue. As this situation arises the banks are in big trouble. The process goes like this, the banks as a lack of credit borrows money from the central bank. This results more money in circulation in the economy. The money borrowed is used to buy more bonds from the government and thus making the open market and the stock market weaker. The ECB is restricted to print more money but then why they have resulted in high debt level. It is because the banks in the EU that caused the dirty picture.  They kept the loans they borrowed from central banks as collateral in buying more government bonds and showed those bonds as collateral to the banks. This over the time resulted in bad debts and investors walked away from investing in the financial instruments of these banks. This is reason the banks went insolvent in 2009 and required large bailout packages to stay in the market.

The government bonds are no longer risk free and became worthless with huge government debt level. Now since the financial market has broken down and people lost confidence in bank deposits and interest in government bonds the EU countries like United Kingdom followed the concept of quantitative easing which is nothing but creating or printing mere money out of thin air. The central bank then bought bond from government which is an indirect way of financing the deficit and spending. Now it is all known that increased attachment to one single policy or activity for a very long time causes a crisis. This is what called as bubble burst. It was housing bubble in the case of US financial crisis and increased spending of European Union government that raised huge debt level. Both the action proved to be working out well for sometime but the lesson one had learned from the ongoing global economic crisis is that all the policies work well and reap benefits in the short run and the politicians and policymakers have to find alternative policies from time to time and implement them to have a sustainable growth. Sticking to the same policy for a long time poses a serious threat in the long run which cannot be mended as easily as is the current situation the Eurozone countries are facing. The latest to join the crisis is the small country of EU, Cyprus.  The banks were shut down for more than a week following the crisis. Its really hard to imagine the banks in Cyprus went bankrupt because this is a country with very small population and the one that once financed the government debts of other European Union countries. The EU has definitely taken action since the crisis reached its peak but is slow as it requires the consent of all other nations. The major course of action so far have been providing a series of bailout packages to save the banks from going bankrupt and troubled economies. The Eurozone member states have created the European Financial Stability Facility (EFSF) to provide financial assistance and emergency lending to countries facing financial difficulty.  The crisis has affected the economic growth as industrial production is getting weaker and many industries like auto sector and shipping have been hit hard by the crisis. This resulted in weak stock market and low investor confidence. The unemployment rates are increasing and people are on streets protesting and moving to other countries outside EU looking forward for better career prospects. The banks also on their part forced the European Union governments to introduce austerity measures. This resulted uproar among the public leading to a change in political parties and political turmoil. The austerity is not the real answer to solve the crisis as it only affects the economic growth which means lower tax revenues for countries to pay their bills in the long run.

Now its clear that whatever maybe the situation, the reason for the huge level of debts is because we are in the pursuit of economic growth ignoring all other factors like financial and environmental stability. People and government all over the world are interested in perpetual growth since the industrial revolution.The continuous urge of the people to improve their standard of living at any cost is called as Hedonic adaptation. The motive of the people or government for that matter, to improve their standard of living is not wrong but what they fail to understand is that the economic and personal growth should be in accordance with the current debt. One of the most important concepts in economics is the opportunity cost. It is the value of the best alternative foregone. Every decisions that we make today have an opportunity cost. If we want to pursue only growth and personal well being then we tend to affect the economic and environmental stability in the process which in future have a cost to pay. And that is mostly serious. Economic downturns following economic crisis are deep and persistent.It is because the global economy is complex and dynamic as everything is interdependent due to globalization. So weighing down between the different situations at hand is essential in making wise decisions that can avoid many problems in the future. The euro crisis that we witness today is just the beginning of a modern debt tragedy.The present situation in Eurozone seems to be gloomy and thus the global economy is heading towards another serious economic disaster perhaps even worse than the one that hit the world in 2008. Its high time that the world leaders work out together to solve the immediate crisis, if not, we have to pay badly as the consequences are very serious. The clock is ticking faster! Leaders please wake up!