• What Caused ‘The Eurozone Crisis’ & How to Solve the Crisis

    by  • 24 March, 2013 • What's Happening? • 4 Comments

    A lot has been said about the European crisis, its causes, its impact on the world and the probable solutions to the crisis. Yet many of us are lost in the event so much that we do not know the exact causes and what triggered the crisis of such a stature. Let us today go through a story which holds a very significant place in the world economic history!

    In order to reduce exchange rate risks and to promote trade, Eurozone was initially formed of 11 member nations namely Austria, Belgium, Finland, France, Germany, Italy, Ireland, Luxembourg, Netherlands, Portugal and Spain. Later on, Greece, Slovenia, Cyprus, Malta, Slovakia, Estonia were also added and today Eurozone has 17 members. The common currency Euro was formed back in 1999 which reflected deep financial integration. It also symbolized a united and prosperous Europe.

    When the Euro came into existence, all of the 11 Eurozone members agreed to a “stability and growth pact” insisted by then German finance minister Theo Waigel. According to the pact, the member states would limit their total borrowing (fiscal deficit) to 3% of their economies’ output each year (GDP). Also, the public debt would be curtailed to 60% of GDP.  If everyone agreed to the pact then what happened wrong? Who kept the rules and who dumped them?

    Italy was the nastiest crook. It broke the 3% borrowing limit on regular basis. But Italy wasn’t alone. Germany was also the first big country to break the rules. Following their footsteps was France. Out of the big economies of Eurozone, Spain was the one to keep its hands clean until the financial crisis of 2008. Spanish government not only kept the promise of less than 3% debt but out of the four countries, it also had the lowest level of debt relative to the size of its economy. Greece on the other hand was playing a different game altogether. It never followed the 3% rule, but manipulated its borrowing data so that it looked good on paper. This was also the way in which it managed to get into euro in the first place. Its defiance was exposed only a few years ago.

    Twist in the story is added. According to the above mentioned facts, the countries of Italy, Germany, and France should have landed in trouble while Spain should have been reaping the fruits of its virtue. But markets have other notions. Germany was considered as “safe heaven” until mid-2011 while Spain was considered as risky as Italy. Interest rates in Germany were lowest and markets were willing to lend to it.

    Spain and Italy had huge accumulation of debts before 2008, but it was private sector debts, who were taking loans, and not that of government combined with exceptionally low interest rates in southern European countries encouraged a debt-fuelled boom. Germany became a major exporter; its exports surpassed its imports by huge amounts. It started earning huge amounts of cash but major fiasco was majority of this cash earned was being lent to southern Europe. The southern countries lost their export competitiveness due to higher labour wages. So, we can see that it was problem of few (PIIGS) counties which spread to the entire Eurozone. The blame of Eurozone debt crisis certainly should go to the crisis countries but the crisis is too big that there are plenty of blames going around.

    As of now, Greece, Ireland and Portugal have lost their access to international capital markets. They are getting bailouts by the IMF and EFSF (European Financial Stability Facility). Money and credit conditions are tightening and austerity measures are being proposed – governments have agreed to significantly cut their spending’s. As part of rescue, a 750 billion euro package was arranged. But due to lack of unified plan to solve the problem and political disagreements the crisis still continues to exist.

    In order to end the crisis, all the Eurozone member countries must come to one consensus. The rich countries like Germany are proposing austerity measures to bring down the debt levels but the same measures will lead to economic slowdown and will make the situation further difficult for the poor countries. There should be agreement between the rich and poor nations else there is a huge risk that nothing will be accomplished and the crisis would only worsen.

    A huge number of economists and investors have suggested that Eurobonds, also called as “stability bonds”, can be one of the best ways to solve the crisis. The bonds would jointly be written by all 17 member states and would be harmonized by changes in EU treaties like tight financial and budgetary coordination. These bonds would efficiently finance the member countries by presumably trading with a low yield. It would also exclude the need for supplementary expensive bailouts and help the members to find their way out of the trouble.

    The problem with Eurobonds is mostly that of contentment. The good side is that it would allow access to cheap financing thereby eliminating the need for adopting austerity measures. The bad side can be that if any country defaults on Eurobond, countries like Germany will have to bear the brunt of financial burden. Hence, Germany endures to be chiefly opposed to this joint seizure.

    So, this was the whole story. Let us now watch for the finale and where will it drive the world economy to!

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    4 Responses to What Caused ‘The Eurozone Crisis’ & How to Solve the Crisis

    1. vinayak date
      24 March, 2013 at 5:15 am

      an incisive piece explaining the complex situation.

    2. 24 March, 2013 at 5:21 am

      wrote the whole article in nice way . Nice understanding to the whole problem

    3. Malhar
      24 March, 2013 at 5:25 am

      nicely written… got a newer perspective of the issue…

    4. Jayant
      24 March, 2013 at 12:56 pm

      Leena!!!!!!!
      Nice article……

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