european crisis final1
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Mayank Gandotra – 11PGDM090
Nikhil Pawa – 11PGDM096
Srinija Appalaraju – 11PGDM113
Sumit Dua – 11PGDM116
Venugopal Kankani – 11PGDM119
Euro Crisis
ContentsAbstract.......................................................................................................................................................4
Keywords.....................................................................................................................................................5
European Crisis............................................................................................................................................6
Going back to the origin..........................................................................................................................6
How did the Euro benefit them?.........................................................................................................6
Situation in Greece..................................................................................................................................7
Situation in Spain.....................................................................................................................................7
Why countries are not defaulting?..........................................................................................................7
The vicious cycle......................................................................................................................................8
The other countries - interconnection.....................................................................................................8
Getting out of Euro?................................................................................................................................9
Measures taken to prevent the crisis........................................................................................................10
Bailout Package.....................................................................................................................................10
Emergency Parachute............................................................................................................................10
European Stability Mechanism..............................................................................................................11
European Central Bank (ECB).................................................................................................................11
Savings package by the Greek Government..........................................................................................11
Proposed 6th measure – Euro Bonds......................................................................................................11
Was the Euro a good idea?........................................................................................................................13
Maastricht Treaty..................................................................................................................................13
Price Stability.............................................................................................................................13
Fiscal Prudence..........................................................................................................................13
Successful EMS Membership.....................................................................................................13
Interest-Rate Convergence........................................................................................................14
How do these benefits of the euro arise?..............................................................................................15
Benefits worldwide................................................................................................................................15
Realizing the benefits............................................................................................................................15
Will the Euro zone disintegrate in the near future?..................................................................................18
Profligacy Diagnosis...................................................................................................................................22
Political Impact..................................................................................................................................24
Economic Impact...............................................................................................................................24
Germany :Central to the solution of the Euro crisis...................................................................................25
Germany’s History in Europe.................................................................................................................25
Germany’s Current Role and Actions.....................................................................................................26
Cost of Breaking Up...............................................................................................................................28
Cost of the Bailout.................................................................................................................................28
The German Decision............................................................................................................................30
References.................................................................................................................................................31
AbstractThe Euro crisis is the impending financial crisis that the entire world is waiting and watching to
unfold. After the financial crisis that hit the global economy in 2007 which preceded by long
period of rapid crdit growth, low risk premiums, abundant availability of liquidity, strong
leveraging and development of bubbles in real estate, this crisis shows features more akin with
the Great Depression of the 1930’s. It started as a acute shortage of liquidity with the financial
institutions which was then worsened by the global meltdown. The interconnections were so
strong that EU GDP is shrunk by so much so fast, that it has never happened before in the
history.
The crisis has bought forward some very thought provoking questions regarding the policies
followed and the changes required in these areas. Some of the questions thrown around are, was
Euro a mistake? Can’t countries just get out? What is the cost of getting out? How did things get
so worse? Another interesting area of focus has been profligacy diagnosis. How much is really
too much spending? How are we supposed to cap it? When can you say “enough”?
From these questions we are now slowly moving to a place where the focus is shifting to Crisis
prevention, Crisis control and mitigation and further Crisis resolution.
Keywords
Bailout Consequences
Euro zone
Euro crisis
Profligacy diagnosis
European Union
European Central Bank (ECB)
European Crisis
Going back to the origin
In 1958, an organization called European Coal and Steel Community was formed. This evolved
into the European Union (EU) which was established by the Maastricht Treaty in 1993. The
European Union introduced the euro on January 1, 1999. On this day, 11 member countries of
the EU started using euro as their currency. It benefited countries such as Portugal, Italy, Ireland,
Greece and Spain (together now known as the PIIGS).
How did the Euro benefit them?
Before these countries started to use the euro as a currency, they had to borrow money at
interest rates much higher than the rates at which a country like
Germany borrowed. When these countries started to use the euro
they could borrow money at interest rates close to that of
Germany, which was economically the best managed country in
the EU.
Another important factor is that the inflation in the PIIGS countries was higher than the
rate of interest which means that if you are borrowing at 3% interest rate but the inflation
rate is 4%, effectively the real interest rate is a negative 1%.
The setting facilitated huge borrowings on the part of these countries, not just the citizens even
the governments started to borrow which helped the politicians keep their constituency of voters
happy.
Situation in Greece
A job which paid x Euros amount in Germany, paid more than x
Euros in Greece, even though Germany is a more productive
nation. To get around the pay restraints in a calendar year Greece government simply paid
employees a 13th or 14th month salaries, month’s that didn’t even exist.
Another aberration was that Greece had classified some jobs as arduous jobs, jobs which require
more hard work. The retirement age for these jobs was 50 for women
and 55 for men. At this point in time the government has giving out
“very” generous pensions and more than 600 Greek professionals
somehow managed to get themselves classified as “arduous”, and these
professionals were people with jobs like hairdressers, musicians etc
All of this led to more and more borrowing by the government when
they already had so much debt.
Situation in Spain
Spain had the biggest housing bubble in the world. To make things clear let us quote some facts,
Spain has as many unsold homes as US even though US is 6 times bigger. Spain’s real estate
debt comes to around 50% of its GDP.
Why countries are not defaulting?
Every time a country defaults, the ECB (European Central Bank) helps out with a bailout. Since
the financial crisis ECB has bailed out $80 billion Greek, Irish and Portuguese government
bonds and lent another $450 billion to various European governments and European banks
accepting virtually at any collateral, including Greek government bonds. Of the 126 countries
who are debt rated, Greece is now ranked 126th.
The vicious cycle
Germany contributes to the ECB rescue fund. The German government gives money to the
rescue fund so that it can give money to the Irish government so that the Irish government can
give money to the Irish banks so that the Irish banks can repay their loan to the German Banks.
Similarly a lot of German and French banks will be in trouble if Greece defaults.
The other countries - interconnection
Let’s start from Hungary. In 2004, the interest rates in Hungary(Not a Euro
using country) were at 12.5% which means that borrowing was extremely
expensive. In neighboring Austria, the banks had started to offer loans and
mortgages to their customers in Swiss francs. Rates in Austria, at 2%, may
have been lower than in Hungary, but in Switzerland, they were even lower at around 0.5%.
Austrians went for a loan at 0.5 %.Same philosophy applied to the Hungarians also, except that
the difference in interest rates was much bigger and Austrian banks in Hungary started offering
German goverment
Rescue fund
Irish government
Irish banks
Repay loans to German banks
loans at their low interest rates. Now Austrian banks have lent 140% of their GDP to other
countries. If these countries are not able to repay, the
Austrian government wouldn’t be able to save the banks and
ECB might have to step in.
Similarly, Swedish banks have also lent a lot of money to
Estonia, Lithuania and Latvia, countries which aspire to have
Euro as their currency some day. So, they are all interconnected.
Getting out of Euro?
The reason why countries cannot simply get out of euro, print their own money and repay the
debts is that printing of money reads to devaluation of the real value of the currency. If that
happens then the citizens of the country would prefer to keep their money in assets that actually
have more value like gold or the euro itself. And in order to do that they would try to get their
money from the bank, if all the depositors line up outside the bank for their money then the bank
will collapse. That’s the problem.
Take the example of Italy, Households and firms, anticipating that domestic deposits would be
redenominated into the lira (Italy's currency before it started using the euro), which would then
lose value against the euro, would shift their deposits to other euro-area banks. A system-wide
bank run would follow. Investors anticipating that their claims on the Italian government would
be redenominated into lira would shift into claims on other euro-area governments, leading to a
bond market crisis and this would be the mother of all financial crises.
Measures taken to prevent the crisis
Broadly classified the following are the measures taken to help Greece fill its debt crater:
Bailout Package
The first measure that was taken was a bailout package amounting to 110 billion Euros
which was put together by the Eurozone countries and the International Monetary Fund
and given as a loan to Green on 2 May 2010.
Loan was provided on conditions that there would be implementation of harsh austerity
measures.
This package was too small to fill the debt crater so other measures had to be taken.
Emergency Parachute
A parachute amounting about 7 times the bailout package was created not just for Greece
but also for other countries that were showing signs of financial weakness.
The 27 EU member states agreed to create the European Financial Stability Facility, a
legal instrument aiming at preserving financial stability in Europe by providing financial
assistance to eurozone states in difficulty. The EFSF can issue bonds or other debt
instruments on the market with the support of the German Debt Management Office to
raise the funds needed to provide loans to eurozone countries in financial troubles.
Measures taken to help Greece
Bailout package = 110 billion Euros
Parachute = 770 billion Euros
Europe's Stabilization Mechanism
European Central Bank (ECB)
Savings package Euro bonds
European CountriesECB Greek Govt.
This money like the bailout package was a loan and was to be given only under the
condition that the governments acted more responsibly in the firm.
It is a short term measure, to last up to 2013, after which they expect the stabilization
mechanism to take effect.
European Stability Mechanism
The European Stability Mechanism (ESM) is a permanent rescue funding program to
succeed the temporary relief provided by the bailout package and the emergency
parachute. The ESM is due to be launched in mid-2013.
German Finance Minister Wolfgang Schaeuble was quoted saying paid-in capital of the
ESM may be around 80 billion Euros, giving it a total capacity of 500 billion Euros.
Again the money is a loan which needs to be paid back by the country that is taking the
loan.
European Central Bank (ECB)
ECB is lending a lot of money to Greece because private banks are very reluctant to give
money to Greece.
This is against the very principle of the ECB, but it has made an exception in this case
because the Greece debt is very huge.
Savings package by the Greek Government
This measure is devised by the Greek government, they have devised a savings package
but the citizens are protesting against this package, because they feel it’s unfair that they
should pay for the mismanagement by the government.
The Greek government also plans to privatize. They will be selling shares of some of its
state businesses.
Proposed 6th measure – Euro Bonds
On 21 November 2011, the European Commission suggested that eurobonds issued
jointly by the 17 euro nations would be an effective way to tackle the financial crisis.
Using the term "stability bonds", Jose Manuel Barroso insisted that any such plan would
have to be matched by tight fiscal surveillance and economic policy coordination as an
essential counterpart so as to avoid moral hazardand ensure sustainable public finances.
Germany remains opposed to take over the debt and interest risk of states that have run
excessive budget deficits and borrowed excessively over the past years. The German
government sees no point in making borrowing easier for states who have the problem
that they borrow so much until they went in a debt crisis. Germany says that Eurobonds,
jointly issued and underwritten by all 17 members of the currency bloc, could
substantially raise the country's liabilities in the debt crisis.
However, a growing field of investors and economists say it would be the best way of
solving the debt crisis.
Guy Verhofstadt, leader of the liberal ALDE group in the European parliament suggested
following a proposal made by the "five wise economists" from the German Council of
Economic Experts, on the creation of a European collective redemption fund. It would
mutualise euro zone debt above 60%, combining it with a bold debt reduction scheme for
countries not on life support from the EFSF.
The introduction of euro bonds matched by tight financial and budgetary coordination
may well require changes in EU treaties, which is widely expected to be discussed at the
9 December EU summit.
Was the Euro a good idea?
To comment on looking at the past of the European Union that whether the creation of the Euro
was good or bad, one should see why the euro was created.
When the EU was founded in 1957, the Member States concentrated on building a 'common
market' for trade. However, over time it became clear that closer economic and monetary co-
operation was needed for the internal market to develop and flourish further, and for the whole
European economy to perform better, bringing more jobs and greater prosperity for Europeans.
In 1991, the Member States approved the Treaty on European Union (the Maastricht Treaty),
deciding that Europe would have a strong and stable currency for the 21st century.
Maastricht Treaty
The Maastricht Treaty stipulates five criteria that countries must meet to become eligible for the
single European currency, the euro. These criteria must be achieved over the year before the date
of examination. As membership will be determined in early 1998, the criteria thus apply to 1997.
They are as follows:
Price Stability
To qualify, a country's inflation rate must not exceed the average inflation rate of the
three best performing Member States by more than 1-1/2 percent. (Inflation is measured
by means of the consumer price index.)
Fiscal Prudence
To qualify, a country must not exceed either of the following two reference values
relative to its gross domestic product at market prices:
1. 3 percent for the ratio of the planned or actual government deficit to GDP;
2. 60 percent for the ratio of government debt to GDP.
Successful EMS Membership
To qualify, a country must have stayed within the normal fluctuation margins provided
for by the Exchange Rate Mechanism of the European Monetary System, for at least two
years, without devaluing against the currency of any other Member State.
Interest-Rate Convergence
To qualify, the durability of convergence must be reflected in the long-term interest rate
levels. A Member State must have had an average nominal long-term interest rate that
does not exceed by more than 2 percentage points that of, at most, the three best
performing Member States in terms of price stability. (Interest rates are measured on the
basis of long term government bonds or comparable securities.)
Some countries indicated that they did not intend to participate immediately in the Euro. These
countries are Britain, Denmark, and Sweden. The only country that did not meet the two most
important criteria, price stability and interest-rate convergence, is Greece, and thus it did not
qualify for membership in 1999. However, by June 2000, Greece has made sufficient progress so
that Greece will join the euro by January 1, 2001. The criterion on successful membership in the
exchange rate mechanism (ERM) of the EMS did not pose a serious threat for membership. In
1999, only Britain, Greece, and Sweden did not participate in the ERM.
The benefits of the euro are diverse and are felt on different scales, from individuals and
businesses to whole economies. They include:
More choice and stable prices for consumers and citizens
Greater security and more opportunities for businesses and markets
Improved economic stability and growth
More integrated financial markets
A stronger presence for the EU in the global economy
A tangible sign of a European identity
Many of these benefits are interconnected. For example, economic stability is good for a
Member State’s economy as it allows the government to plan for the future. But economic
stability also benefits businesses because it reduces uncertainty and encourages companies to
invest. This, in turn, benefits citizens who see more employment and better-quality jobs.
How do these benefits of the euro arise?
The single currency brings new strengths and opportunities arising from the integration and scale
of the euro-area economy, making the single market more efficient.
Before the euro, the need to exchange currencies meant extra costs, risks and a lack of
transparency in cross-border transactions. With the single currency, doing business in the euro
area is more cost-effective and less risky.
Meanwhile, being able to compare prices easily encourages cross-border trade and investment of
all types, from individual consumers searching for the lowest cost product, through businesses
purchasing the best value service, to large institutional investors who can invest more efficiently
throughout the euro area without the risks of fluctuating exchange rates. Within the euro area,
there is now one large integrated market using the same currency.
Benefits worldwide
The scale of the single currency and the euro area also brings new opportunities in the global
economy. A single currency makes the euro area an attractive region for third countries to do
business, thus promoting trade and investment. Prudent economic management makes the euro
an attractive reserve currency for third countries, and gives the euro area a more powerful voice
in the global economy.
Scale and careful management also bring economic stability to the euro area, making it more
resilient to so-called external economic 'shocks', i.e. sudden economic changes that may arise
outside the euro area and disrupt national economies, such as worldwide oil price rises or
turbulence on global currency markets. The size and strength of the euro area make it better able
to absorb such external shocks without job losses and lower growth.
Realizing the benefits
The euro does not bring economic stability and growth on its own. This is achieved first through
the sound management of the euro-area economy under the rules of the Treaty and the Stability
and Growth Pact (SGP), a central element of Economic and Monetary Union (EMU). Second, as
the key mechanism for enhancing the benefits of the single market, trade policy and political co-
operation, the euro is an integral part of the economic, social and political structures of today’s
European Union.
So, creation of neither a good idea nor a bad idea, as it could be seen from the below pros and
cons. It was a good notion of introducing a common currency but allowing countries like Greece
to have a spendthrift government and not monitoring them at the correct time were the reason
that this good notion has turned into a bad idea.
Pros and Cons for and against the Euro while the Euro was getting created:
Arguments for a single European currencyArguments against a single European
currency
Transaction Costs
Having to deal with only one currency
will reduce the cost of converting one
currency into another. This will benefit
businesses as well as tourists.
No Exchange Rate Uncertainty
Eliminating exchange rates between
European countries eliminates the risks
of unforeseen exchange rate revaluations
or devaluations.
Transparency & Competition
The direct comparability of prices and
wages will increase competition across
Europe, leading to lower prices for
consumers and improved investment
opportunities for businesses.
Strength
The new Euro will be the among the
Cost of Introduction
Consumers and businesses will have to
convert their bills and coins into new
ones, and convert all prices and wages
into the new currency. This will involve
some costs as banks and businesses need
to update computer software for
accounting purposes, update price lists,
and so on.
Non-Synchronicity of Business Cycles
Europe may not constitute an "optimum
currency area" because the business
cycles across the various countries do
not move in synchronicity.
Fiscal Policy Spillovers
Since there will only be a Europe-wide
interest rate, individual countries that
increase their debt will raise interest
rates in all other countries. EU countries
strongest currencies in the world, along
with the US Dollar and the Japanese
Yen. It will soon become the 2nd-most
important reserve currency after the US
Dollar.
Capital Market
The large Euro zone will integrate the
national financial markets, leading to
higher efficiency in the allocation of
capital in Europe.
No Competitive Devaluations
One country can no longer devalue its
currency against another member
country in a bid to increase the
competitiveness of its exporters.
Fiscal Discipline
With a single currency, other
governments have an interest in bringing
countries with a lack of fiscal discipline
into line.
European Identity
A European currency will strengthen
European identity.
may have to increase their intra-EU
transfer payments to help regions in
need.
No Competitive Devaluations
In a recession, a country can no longer
stimulate its economy by devaluing its
currency and increasing exports.
Central Bank Independence
Previously, the anchor of the European
Monetary System has been the
independence of the German
Bundesbank and its strong focus on price
stability. Even though the new European
Central Bank (ECB) will be nominally
independent, it will have to prove its
independence. This will at the very least
incur temporary costs as it will have to
be extra-tough on inflation.
Excessive Fiscal Discipline
When other governments exert pressure
on a government to reduce borrowing, or
even pay fines if the budget deficit
exceeds a reference value, this may have
the perverse effect of increasing an
existing economic imbalance or
deepening a recession
Will the Euro zone disintegrate in the near future?
Many economists and political leaders are pondering on the question 'When will the Euro zone
collapse?' and not on 'Will the Euro zone collapse?'. But many
others have the view that European leaders won't let the Euro
zone to disintegrate as the break-up would be too dreadful to
contemplate. Let us first consider the costs involved in the break-
up.
Even as the euro zone hurtles towards a crash, most people are
assuming that, in the end, European leaders will do whatever it takes to save the single currency.
That is because the consequences of the euro’s destruction are so catastrophic that no sensible
policymaker could stand by and let it happen. If Euro zone disintegrate, the world’s most
financially integrated region would be ripped apart by defaults, bank failures and the imposition
of capital controls. The euro zone could shatter into different pieces, or a large block in the north
and a fragmented south. We consider two scenarios. One, Germany could leave, either on its
own or with a select group of small economies. Second, Greece might secede or be forced out.
According to UBS, if a stronger country like Germany were to leave, the cost for every German
adult and child would range from 6,000 to 8,000 Euros ($8,000 to $10,600), or about 20 to 25
percent of its annual GDP. If a weak country like Greece left the euro, the economic costs would
be severe. Leaving the euro would cost each "weak country" citizen between 9,500 to 11,500
Euros ($12,650 to $15,300), or about 40 to 50 percent of that country's GDP. And that's just in
the first year.A eurozone crash, the European commission has predicted, would see £10 trillion
wiped off the value of the European economy, a catastrophe that would send living standards
plummeting to the levels of Latin America. The shock would wipe out all the gains of Europe’s
longest period of peace since the Second World
War and herald the political chaos and collapse of
governments that ushered in Nazism 80 years ago.
Yet the threat of a disaster does not always stop it
from happening. The chances of the euro zone
being smashed apart have risen alarmingly, thanks
to financial panic, a rapidly weakening economic outlook and pigheadedbrinkmanship. The odds
of a safe landing are dwindling fast.Investors’ growing fears of a euro break-up have fed a run
from the assets of weaker economies, a stampede that even strong actions by their governments
cannot seem to stop. The latest example is Spain. Despite a sweeping election victory on
November 20th for the People’s Party, committed to reform and austerity, the country’s
borrowing costs have surged again. The government has just had to pay a 5.1% yield on three-
month paper, more than twice as much as a month ago. Yields on ten-year bonds are above
6.5%. Italy’s new technocratic government under Mario Monti has not seen any relief either: ten-
year yields remain well above 6%. Belgian and French borrowing costs are rising. And this
week, an auction of German government Bunds flopped.The panic engulfing Europe’s banks is
no less alarming. Their access to wholesale funding markets has dried up, and the interbank
market is increasingly stressed, as banks refuse to lend to each other. Firms are pulling deposits
from peripheral countries’ banks. This backdoor run is forcing banks to sell assets and squeeze
lending; the credit crunch could be deeper than the one Europe suffered after Lehman Brothers
collapsed.
Past financial crises show that this downward spiral can be arrested only by bold policies to
regain market confidence. But Europe’s policymakers seem unable or unwilling to be bold
enough. The much-ballyhooed leveraging of the euro-zone rescue fund agreed on in October is
going nowhere. Euro-zone leaders have become adept at talking up grand long-term plans to
safeguard their currency—more intrusive fiscal supervision, new treaties to advance political
integration. But they offer almost no ideas for containing today’s conflagration.The European
Central Bank (ECB) rejects the idea of acting as a lender of last resort to embattled, but solvent,
governments. The fear of creating moral hazard, under which the offer of help eases the pressure
on debtor countries to embrace reform, is seemingly enough to stop all rescue plans in their
tracks. Yet that only reinforces investors’ nervousness about all euro-zone bonds, even
Germany’s, and makes an eventual collapse of the currency more likely.This cannot go on for
much longer. Without a dramatic change of heart by the ECB and by European leaders, the
single currency could break up within weeks. Any number of events, from the failure of a big
bank to the collapse of a government to more dud bond auctions, could cause its demise. If the
markets balk, and the ECB refuses to blink, the world’s third-biggest sovereign borrower could
be pushed into default.
Germany’s unwillingness to share the pain and save the Euro zone illustrates the fundamental
problem of the monetary union. Historically, the success of monetary unions depended largely
on two factors: the similarity of the economies and the will to stay together. The Euro zone is
weak in these two factors. The economies of persistent trade-surplus countries like Germany are
significantly different from persistent trade-deficit countries like Greece. These countries should
not share one currency and one monetary policy. This discrepancy could conceivably be solved
if Germany subsidizes Greece forever. However, such permanent fiscal transfers are politically
impossible in the Euro zone, where Germans are Germans and Greeks are Greeks. Indeed, each
Euro zone member is its own country.
Can anything be done to avert
disaster? The answer is still yes, but
the scale of action needed is growing
even as the time to act is running
out. The only institution that can
provide immediate relief is the ECB. As the lender of last resort, it must do more to save the
banks by offering unlimited liquidity for longer duration against a broader range of collateral.
Even if the ECB rejects this logic for governments—wrongly, in our view—large-scale bond-
buying is surely now justified by the ECB’s own narrow interpretation of prudent central
banking. That is because much looser monetary policy is necessary to stave off recession and
deflation in the euro zone. If the ECB is to fulfill its mandate of price stability, it must prevent
prices falling. That means cutting short-term rates and embarking on “quantitative easing”
(buying government bonds) on a large scale. And since conditions are tightest in the peripheral
economies, the ECB will have to buy their bonds disproportionately.
Vast monetary loosening should cushion the recession and buy time. Yet reviving confidence
and luring investors back into sovereign bonds now needs more than ECB support, restructuring
Greece’s debt and reforming Italy and Spain—ambitious though all this is. It also means creating
a debt instrument that investors can believe in. And that requires a political bargain: financial
support that peripheral countries need in exchange for rule changes that Germany and others
demand.This instrument must involve some joint liability for government debts. Unlimited
Eurobonds have been ruled out by Mrs. Merkel; they would probably fall foul of Germany’s
constitutional court. One promising idea, from Germany’s Council of Economic Experts, is to
mutualise all euro-zone debt above 60% of each country’s GDP, and to set aside a tranche of tax
revenue to pay it off over the next 25 years. Yet Germany, still fretful about turning a currency
union into a transfer union in which it forever supports the weaker members, has dismissed the
idea.This attitude has to change, or the euro will break up. Fears of moral hazard mean less now
that all peripheral-country governments are committed to austerity and reform. Debt
mutualisation can be devised to stop short of a permanent transfer union.
Hence we can say that unless Germany and the ECB move quickly, the single currency’s
collapse is looming.
Profligacy Diagnosis
When European Union was inducting countries into its ambit, it sets out clear conditions which
were prerequisites for a country to fulfill so as to become a member of EU. These conditions also
included a cap on fiscal deficit which is not to be exceeded by 3 % of the GDP. But even
countries like Greece who were running large deficits at that time were able to enter into the
Union by fudging their account books. Even after becoming member of the EU, they did not try
to comply with the rules and keep on running large deficits. So this excessive state spending has
led to unsustainable levels of debt and deficits that have threaten economic welfare of the EU
countries. So when Greece national debt mounted up due to losses in the main industries i.e.
tourism and shipping due to economic crisis of 2008, they approached IMF to seek help but
being thrashed for running such large deficits. It was being asked to implement some harsh
austerity measures as Greece was running a fiscal deficit of 12.7 % of GDP. The below graphs
show the fiscal deficits and public debts of various member countries of European Union.
Now profligacy in the past by these countries is considered to be one of the major reasons for
their current situation. Even the Europe’s countries which are running surpluses are right in
claiming that the euro would work if effective discipline could be imposed on others, but they
are deluding themselves from the mortality play. If we take the case of Spain and Ireland who
were running budget surpluses till 2007 became the victim of banking and property bust. Even
Italy was maintaining a big but stable public debt. So we can infer that although the symptoms of
these countries might be the same but the reasons are different so the diagnosis cannot be on the
same lines for all countries.
Moreover the diagnosis prescribed doesn’t address today’s problem which is huge debts.
The austerity measures taken by the government like increase in tax and decrease in government
spending just ensure that they will be able to manage their finances in the coming future but
paying off the previous debts is the monster hunting the Euro Nations.Any kind of austerity
measure will led to following effects on the economy:
Political Impact In the countries like Greece where people are not ready to pay high taxes and
they will unwelcome this measure and there may be internal unrest in the country the signs of
which are visible in the current situation itself.
Economic Impact Less spending by government will stall the growth of the country. Thus it will
severely affect the unemployment rate and it can further put the country into deeper recession.
And the Europe’s leaders know this. They know that the growth is needed. But rather
than deal with today’s problem and find a solution for growth, they prefer to deliver homilies
about what some previous government should have done. This may be satisfying for the
sermonizer but it won’t solve Europe’s problems and it won’t save euro.
Germany :Central to the solution of the Euro crisis
Germany’s History in EuropeGermany was one of the founding nations of the European Union, which was designed to ensure
that the continent would never again be torn apart by war. Following World War II, Germany's
neighbors wanted to hobble any future attempts by the nation to remilitarize; the French decided
that the best way to do this was economically, rather than ideologically.
The new Europe was built around that Franco-German relationship, starting from a clean slate.
European integration became a part of the rehabilitation of Germany as a nation among nations.
In the post-war years, West Germany enjoyed a massive boom, as the nation made the most of
the support it was offered and the opportunities that came its way to recover from the devastation
of WWII. West Germany flourished in the 1950s, 60s and 70s while other European nations,
including France and Britain, struggled.
But reunification with East Germany in 1990 following the fall of the Berlin Wall and the
collapse of the Soviet Union dented the country's fortunes. Resources had to be transferred from
rich regions to poorer ones. The government ended up overspending and had to make
fundamental economic reforms. However, they were able to reform at the right time.
Ever since, Germany has been the economic powerhouse of Europe, but the nation is not
immune to the global financial crisis. It is the continent's largest economy, but it also has a high
rate of government debt, at 83.2% of GDP, and higher unemployment -- at 7.1% -- than many of
its neighbors, according to 2010 figures. Much of Germany's might comes from its strong
manufacturing sector, which has meant that, unlike many of its neighbors, the country has not
had to rely on the financial services industry or the property market, both of which have been
badly hit by the global economic crisis.
In the present scenario, it is understandable that there is a degree of resentment on the part of
German citizens, when faced with the responsibility of clearing up another neighbor's mess. But
so was the case when West Germany rescued East Germany.
Germany is now in a Catch-22 situation. The Americans, and others, demand that Germany takes
action, but when they do, they are accused of trying to “take over” Europe once again.
Germany’s Current Role and Actions
Germany's role in the economy of the region is extremely crucial. This has been becoming more
and more apparent as the crisis has deepened. The reason is quite simply that Germany has the
largest economy in Europe and hence, the fate of Europe depends on Germany. While the
economies of most European Union countries have been languishing since 2008, Germany's
economy has been booming since the country managed to quickly emerge from the global
financial crisis that hobbled many others. However, Germany is stalling in taking the steps
necessary to resolve the crisis. The continuation of the crisis has so far benefited rather than
damaged Germany’s economic interests. The euro/dollar rate is kept lower than it would be in
the absence of a crisis, thus helping German exports. In addition, the German government’s
borrowing rates are lowered by the flight of capital from the bonds of eurozone countries into
German bonds.
But there are recent indications that even the German economy is slowing down and, before
long, is bound to be adversely affected by the contractionary policies of its European trading
partners. GDP in the last quarter went up just 0.1 per cent. Industry sales have stagnated and
foreign demand for German products is falling.
There are numerous measures that would help end the crisis that Germany is resisting. The first
one is the creation of a European Treasury. The common treasury must be able to raise taxes
across the eurozone, coordinate and control national fiscal policies, issue bonds and perform all
the functions required of a federal state treasury, while being accountable to the European
Parliament. It is easier said than done, however, there is no doubt that this would be a truly great
step forward in the deepening of European integration and the realization of a federal state.
The second major necessary reform concerns the role of the European Central Bank (ECB). The
ECB should be responsible not only for the containment of inflation but also for the proper
functioning of the financial system across the euro zone. It must be empowered to control the
banking system without constraints and, in exchange, operate without inhibitions as the lender of
last resort for both financial institutions and national treasuries. Either one of these two reforms
would be, in all likelihood, a sufficient response to the crisis. The two reforms constitute jointly
the first-best solution to Europe’s financial problems. If they were adopted, not only could the
present crisis immediately come to an end, but it might also serve as a decisive step towards a
federal Europe.
This would be in the best tradition of European integration, which has tended to proceed by
resolving problems caused from incomplete though politically feasible previous measures. But
politicians, with their eyes firmly fixed on their electoral chances and on political alliances
necessary to governmental coalitions, are not currently ready for such major advances.
Opposition to the creation of a European Treasury is, of course, understandable among euro-
skeptical political parties. Any move towards a common treasury clearly implies a reduction of
national sovereignty, as national fiscal policy will need approval and may be subject to a possible
veto by institutions at the European level. Ironically, the present crisis serves as a caution against
possible, unseen, ill-effects of such a step in the future.
Moreover, a common treasury would have to take a view of the economic situation and needs
throughout Europe and redistribute resources, most likely from the strongest to the weakest
countries and regions. Thus, it is not surprising that political leaders in Germany and other
economically strong countries would be opposed to this reform.
There is also German opposition to expanding the power and responsibilities of the ECB. This is
based on the fear that, by allowing the ECB to directly lend to governments, the euro will be
debased and hyperinflation will follow.
But central banks all over the world lend to their governments without causing hyperinflation.
The remote possibility of huge mismanagement sometime in the future does not justify taking
today the extreme risk of a financial meltdown that can easily be averted by an adequately
empowered central bank.
It is now imperative that national prejudices are set aside and Germany reasserts the primacy of
the European project by leading the way towards a federal Europe. This means that two things
should be done immediately: First, empowerment of the ECB to lend to solvent states, so as to
calm the waters and restore confidence in financial markets.
Second, immediate announcement of a summit to prepare a new European Treaty establishing a
common treasury and making a major advance in the construction of a federal European state.
Cost of Breaking UpA breakup of the euro zone would have grim, long-lasting social and political consequences that
extend far beyond its economic costs — an ugly risk that is widely underestimated, according to
UBS AG, a Swiss bank.
The economic costs of breaking up the euro are high, and extremely damaging. The political
costs of breaking up the euro, even in part, are too great to quantify in bald cash terms.
Following a breakup, euro countries would barely have a whisper on the world stage. It has been
seen how past instances of monetary union breakups tend to spark either an authoritarian
response from the government or create social disorder and civil war.
Sovereign default, corporate default, collapse of the banking system and international trade are
just some of the problems a seceding peripheral euro-zone country would have to face. That
could entail an initial cost of around 9,500-11,500 euros per person in that country followed by
an annual cost of 3,000-4,000 euros per person. Even if a stronger country like Germany were to
leave, UBS still thinks it is going to set every German back by about 6,000-8,000 euros in the
first year and then around 3,500-4,500 euros per person in every year thereafter. A stronger euro-
zone country wouldn’t face sovereign default but it is still vulnerable to corporate default,
recapitalization of the banking system and a collapse of international trade.
By contrast, each German would only have to cough up 1,000 euros just once to bail out Greece,
Ireland and Portugal entirely, according to UBS’s analysis. However, this argument alone is not
justification enough for the Germans.
Cost of the BailoutOf the 126 countries with a Standard & Poor's rated debt, Greece ranks 126th, winning the award
of the country perceived as the least likely to repay its debt. Greece is not alone in its misery in
the E.U. There’s Portugal and its junk-like debt; Italy and France, which may soon follow the
United States into the ignominy of downgraded credit ratings; and Spain, which just
acknowledged its debt is deeper than it thought.
The only major European economy left standing is Germany. Some of the continent's smaller
countries, like Finland, are doing well, but Germany stands head and shoulders above its E.U.
partners in its ability to bail out deadbeat neighbors. With an unemployment rate of 6.4 percent
(France stands at 9.5 percent) and relatively high private saving rates compared to other
countries (12.1 percent), Germany has been growing at a 2.6 percent rate when everyone is
suffering from anemic growth.
However, political concerns also factor in. Chancellor Angela Merkel finds herself in a tough
spot. Her popularity is at its lowest point since 2006; her party was just trounced in recent local
elections. Germany bailed out fiscally irresponsible countries for fear that a Greek or Irish
default would trigger a bank run in other weak countries like Portugal and Spain. A continent-
wide bank run, the Germans reasoned, might destroy Europe's banking system. But Germans are
increasingly unhappy and morally outraged with the situation. They've already bailed out Ireland,
Greece and Portugal. Now they are being told that more money is needed. In addition, they
understand that if Greece defaults on its debt, the European Central Bank might face insolvency
along with other E.U. countries. All those beggared institutions would then turn for funds to its
one solvent member government: Germany. That means yet more bailouts. Germans are
especially losing patience over the continued demonstrations in Greece over the government’s
austerity measures which they see as signs that the Greeks are uninterested in changing the
behaviors that got them into trouble in the first place.
But so far, German outrage is mainly moral. That can change quickly. They spent years of
paying extra taxes toward the successful German reunification (without any help from other
countries). They've bailed out profligate countries. Now they are being asked for still more.
The bailouts so far haven't cost Germans a euro since the real costs are mostly in the future. But
once Germans internalize all the costs they have already paid or may be on the hook for, their
attitude may change quickly. As new bailouts are requested, as countries fail to reform their
bloated welfare states, no one can be surprised if the Germans start seriously questioning their
attachment to European solidarity. Why should they work two or three extra years to pay for
their neighbors' early retirement policies? And nobody can deny the logic behind that question.
However, it is a tricky situation due to the high future cost to itself of denying its neighbors any
more help. On the other hand is the option that lets its feckless, profligate neighbors easily off
the hook and might let them get away without reform or rectitude (or at least that is how the
Germans would see it for now).
One can draw a parallel to the biblical proverb - spare the rod, spoil the child! Of course not! The
other option is - pick up the rod and thrash the child! Harsher still?
The German DecisionGermany, without asking for it, now plays a central role in effecting the outcome of the Euro
Crisis. There are going to be massive costs for the country one way or the other. Be it from the
disorderly breakup of the euro zone and a move to the old currency or the cost of a bailout for the
struggling neighbors. The decision is a difficult one. It has to be made keeping long term
interests in mind, both for the country itself as well as for the EU, which would, sooner or later,
have consequences for Germany. And then some for the rest of the world.
References
http://www.rediff.com/business/slide-show/slide-show-1-all-about-european-debt-crisis-in-
simple-terms/20110819.htm
http://en.wikipedia.org/wiki/European_sovereign_debt_crisis
http://en.wikipedia.org/wiki/Eurozone
http://www.ibtimes.com/articles/248284/20111112/eurozone-collapse-2011-endgame-
begins.htm
http://www.telegraph.co.uk/finance/financialcrisis/8882812/Eurozone-collapse-will-send-
continent-into-depression.html
http://www.economist.com/node/21540255
http://www.ft.com/intl/cms/s/0/5030759e-49bd-11e0-acf0-00144feab49a.html#axzz1gGlqRgrK
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