18-10-2012, 05:15 PM
WILL EU SURVIVE THE SECOND DECADE OF THE NEW MILLENNIUM
WILL EU SURVIVE THE SECOND DECADE.pdf (Size: 537.78 KB / Downloads: 20)
Introduction
The Euro zone crisis that started in 2009 is showing no sign of abating despite so much discussion and plethora of steps (including the just concluding EU crisis summit at Brussels). What started off as a small problem in fringe European countries is now showing signs of turning into a contagion and threatening to engulf entire global economy into a depression. The Global Markets are fast losing confidence in the European countries. The yields on European government bonds are the highest they have ever been. And the problem is that the issue is so mired in political intransigencies, conflicting economist and public opinions that it is near impossible to find a workable solution to Eurozone problem. It is imperative that a workable solution to the crisis is found soon to restore confidence in global economy and avoid the imminent double dip recession. In the next segments we discuss how and why the crisis happened, what are the likely future scenarios and the possible solution to the crisis.
Background to the Europe Crisis
Examining the steps leading to the crisis in Europe:
Formation of the Eurozone
The Maastricht Treaty, signed in 1992, marked the establishment of the European Union paving the path for monitory and fiscal integration of Europe. The European Monetary Union was launched with 11 member states with a common Euro Currency. Greece joined the Union in 2001. The Union allowed financially weaker countries like Portugal, Italy, Ireland, Greece and Spain to borrow money at same rates as stronger Germany and France giving them a strong incentive to borrow money to fund various government welfare programmes. This Union also benefitted Germany as they got access to common European market and their exports became cheaper globally due to moving from the strong Deutsch Mark to relatively less strong Euro. However, during the boom period of Europe (2001-2008) foundations of the crisis were also laid:
• Availability of low interest rates led more and more people and governments to buy on credit
• The provisions in Maastricht Treaty regarding debt levels and Govt deficit were ignored
Beginning of the Crisis
In 2008, U.S. Financial Crisis started with the Collapse of Lehmann Brothers. This crisis had huge impact throughout the globe with economic outputs decreasing and global sentiments becoming bearish. In Europe, it led to European banks parking their capital in “safe” Government bonds, including those of Italy and Greece. By 2010, European banks had invested €700 billion in bonds of the five crisis stricken countries. Financial crisis was also accompanies by bursting of housing bubbles everywhere including Ireland and Spain. Irish Govt assumed the debt of its banks and became a part of the PIIGS. In Spain, Italy and Portugal too the debt situation steadily worsened. In 2009, the rating agencies downgrade
Greece’s creditworthiness after it reports that its current account deficit is actually 12.5 percent of its GDP. There was a flight of capital from Greek bonds. The spread on Greek bonds increased and the spiral down the rabbit hole started.
Contagion Effect
The crisis of confidence soon spread to other European Currencies. Yields on Italian Govt bonds started to rise reaching a level more than 7 percent. Moody’s cut Portugal’s credit rating to Junk status. Ireland also required a rescue package. Spain currently faces high debt, high unemployment and low growth. By the end of 2013, the total financial need of PIIGS stands at €795 billion. While the problem has been continuously worsening, the European policy response to deal with it remains inadequate. The contagion now threatens to spread to France, then even Germany and then to rest of the world.
Pieces of the Puzzle
Although the magnitude and seriousness of the problem is clear to everyone, the problem remains intricately complex and seemingly unsolvable. No two experts agree on how to deal with the crisis. The reasons for the complexity are:
Size of the Debt
Debt as a proportion of GDP has been rising for most European nations and is at alarming levels for PIIGS. To service the total debt of PIIGS might require total aid to the tune of €1.3 trillion while the current commitment is only €600 billion.