Courtesy Sean Gallup (Getty Images)
Every few days, there seems to be a new headline in the news about how “the Eurozone is in crisis!” Yes, since 2008 Europe has been having financial problems like the rest of the developed world. Ok. But why are they the crisis spot when tons of other places are having a rough time of it too? Big newspapers aren’t saying the same thing about the US anymore, so why focus on Europe?
Fear not dear reader. I shall be sloughing it through those Economist articles so you don’t have to. When the Federal Reserve thinks the US economy is in trouble, they generally flood the markets with a little extra cash (it’s more complicated than this, but this simplification will suffice). Why doesn’t Europe do this? Well, because the Eurozone is a system of several countries adopting the same currency — this lowers transaction and trade costs. While the economies were still doing well, everyone was convinced the system was working. However, after the crisis it became clear that the central monetary authority, the European Central Bank (ECB), was largely handicapped because individual countries still had to vote to approve measures. Greece, for example, is in huge trouble. Germany, on the other hand, is doing just fine. Central bank policies must be the same throughout. As a voting party in a loose union, (never mind the main source of funds) Germany can object — and object it does.
However, the problem became so severe and the Greeks so deeply in debt that even their government bonds were rated as ‘junk’ because nobody believed they could be repaid. Investors were essentially worried that Greece was going to collapse because Germany (and to a lesser extent France) were not willing to do what was necessary to save them, only barely creating bail outs — and never without a large number of strings attached. This was not unfounded thinking — after all, why should they fund the poor decision-making of their peers? They were the hard-workers and Greece the prodigal son, returned home from partying a little too hard. However, their lack of action led to fears that the entire system of the euro was under threat — Greece’s woes were pulling the whole system down.
Over the summer, there were increasing calls for a “Grexit” or an exit of Greece from the euro. Greece could then devalue their currency to stave off collapse, and the rest of the EU could become more stable. However, even if Greece was the most toxic, there were fears about other economies as well. If Greece exited, what about Ireland, Portugal, Italy, and Spain? They too were all in deep straits. And Spain is the EU’s fourth-largest economy. If all these countries were forced to leave, many feared it would be a downward spiral the EU would not recover from. And the collapse of the euro? According to the former head of the World Bank, that “runs the risk of sparking a Lehman-style global crisis that will have dire consequences.”
Fear not dear reader. I shall be sloughing it through those Economist articles so you don’t have to. When the Federal Reserve thinks the US economy is in trouble, they generally flood the markets with a little extra cash (it’s more complicated than this, but this simplification will suffice). Why doesn’t Europe do this? Well, because the Eurozone is a system of several countries adopting the same currency — this lowers transaction and trade costs. While the economies were still doing well, everyone was convinced the system was working. However, after the crisis it became clear that the central monetary authority, the European Central Bank (ECB), was largely handicapped because individual countries still had to vote to approve measures. Greece, for example, is in huge trouble. Germany, on the other hand, is doing just fine. Central bank policies must be the same throughout. As a voting party in a loose union, (never mind the main source of funds) Germany can object — and object it does.
However, the problem became so severe and the Greeks so deeply in debt that even their government bonds were rated as ‘junk’ because nobody believed they could be repaid. Investors were essentially worried that Greece was going to collapse because Germany (and to a lesser extent France) were not willing to do what was necessary to save them, only barely creating bail outs — and never without a large number of strings attached. This was not unfounded thinking — after all, why should they fund the poor decision-making of their peers? They were the hard-workers and Greece the prodigal son, returned home from partying a little too hard. However, their lack of action led to fears that the entire system of the euro was under threat — Greece’s woes were pulling the whole system down.
Over the summer, there were increasing calls for a “Grexit” or an exit of Greece from the euro. Greece could then devalue their currency to stave off collapse, and the rest of the EU could become more stable. However, even if Greece was the most toxic, there were fears about other economies as well. If Greece exited, what about Ireland, Portugal, Italy, and Spain? They too were all in deep straits. And Spain is the EU’s fourth-largest economy. If all these countries were forced to leave, many feared it would be a downward spiral the EU would not recover from. And the collapse of the euro? According to the former head of the World Bank, that “runs the risk of sparking a Lehman-style global crisis that will have dire consequences.”
That changed a couple months ago. Mario Draghi, head of the ECB, finally vowed “to do ‘whatever it takes’ to preserve the euro.” This helped bolster investor confidence. But was it going to be enough? The ECB and the important parties have dragged their feet at every turn. Even now, there are quarrels from within. Notably, the head of the German Bundesbank, the only person to vote against Draghi’s plan, claimed that with this plan the “monetary system [could be] destroyed by rapid currency depreciation.” He was also quick to cite inflationary worries in a system he believed was tantamount to simply printing money. What would be so bad about depreciation? Certainly it would make European exports more competitive and bolster economies, including Germany’s. However, that massive depreciation would come at the heavy cost of imports becoming excessively expensive. Consumer lifestyle suffers; each European will find the same income will now buy them less. For a country like Greece, that is an acceptable price to pay in the face of state bankruptcy; for a country like Germany, that seems like a cost they would rather not bear. Yet Draghi’s plan to utilize the ECB’s printing press is going into action anyway. Greece lives to fight another day. For the moment, the markets rest easy. European leaders at last seem committed to keeping the euro alive. This is all good news for the euro. But it is still only the start for a system seriously under siege.
Sources
http://www.nytimes.com/2010/04/28/business/global/28drachma.html
http://www.economist.com/blogs/charlemagne/2012/06/germany-and-future-euro-1
http://www.guardian.co.uk/business/2012/jun/16/world-bank-euro-collapse-crisis
http://www.nytimes.com/2012/10/05/business/global/european-central-bank-leaves-interest-rates-unchanged.html?pagewanted=2
http://www.ft.com/cms/s/0/558d7996-01af-11e2-8aaa-00144feabdc0.html#axzz28SkudCsX
http://online.wsj.com/article/SB10000872396390443507204578020323544183926.html