Matt Quigley
Matt Quigley

Eurozone crisis: Where things stand

On Tuesday, President Jacob Zuma’s office announced that South Africa will contribute $2-billion (R16.3-billion) to an international fund created to bail out Europe’s debt-stricken nations. The government’s pledge is part of a $75-billion commitment from the Brics nations – Brazil, Russia, India, China and South Africa – to help bolster a $456-billion rescue fund administered by the International Monetary Fund (IMF).

Adding the IMF’s resources to Europe’s own rescue funds, the €500-billion European Stability Mechanism (ESM) and €200-billion European Financial Stability Facility (EFSF) brings the total amount set aside over the past two years to help stabilise the situation in Europe to more than $1.3-trillion.

That is an enormous sum of money, an amount equal to almost three times South Africa’s entire economy. But even this may not be enough to prevent an economic catastrophe.

Four European countries – Greece, Ireland, Portugal and Spain – have already received bailouts from the European Union and IMF totalling more than €500-billion. Spain’s request was specifically targeted to the country’s troubled banking sector, but fears are mounting that the country may soon require a second, general bailout. Italy may need assistance as well and the situation in Greece is far from stable.

US banking giant JP Morgan estimates that Spain has about €350-billion in borrowing needs over the next two years. Italy’s requirements are even larger, €670-billion. Combined, that is over €1-trillion, more than enough to swamp current rescue funds.

The problem for both countries is that fears over their debt, banking systems and economic situations have driven bond yields, representing the cost of borrowing, to unsustainable levels. Unless these yields are brought down, the two countries may find themselves unable to access bond markets, through which government borrowing occurs.

If one or both countries find themselves ‘shut out’ of the market, and are unable to access emergency financing, they could default on their debts. Because banks and other governments hold this debt, such an eventuality would have devastating consequences for the global financial system and economy, including the possible destruction of the eurozone, Europe’s 17-member common currency bloc.

How did we get here?
Europe’s debt problem has been a long time in the making, but the current crisis can be traced back to 2009. In the wake of the global financial crisis that triggered the ‘Great Recession’, deeply indebted Dubai World, a Mideast property developer, found itself in financial trouble.

Investors had assumed that Dubai World’s debts would be backed by government but in November 2009, officials said that they would not assume liability for the developer’s debt. This prompted fears among investors that other government debt was not as safe as previously assumed.

Greece, whose debt totalled €300-billion or 113% of gross domestic product (GDP) – the broadest measure of the size of a country’s economy – quickly found itself in the firing line. By January 2010, concerns spread from Greece to other deeply indebted European countries, including Ireland, Portugal, Spain and Italy.

By May 2010, the situation had deteriorated so badly that Greece was forced into a €110-billion bailout by European leaders and the IMF. In November 2010, Ireland received an €85-billion rescue. Portugal followed with a €78-billion package in May 2011.

Despite these interventions, the situation continued to worsen throughout Southern Europe and, in March of this year, Greece was forced into a second €130-billion bailout that included an agreement with private bondholders to write-down a massive portion of the country’s existing debt. Early this month, Spain requested €100-billion in funds to shore up the country’s fragile banking system.

Because the Spanish government is on the hook for these funds, demand for Spanish bonds continued to fall, driving bond yields (borrowing costs) to record highs. Italy’s were not far behind. Both have since dropped, somewhat, but are still too high for comfort.

What can be done about it?
Since the crisis erupted in 2009, Europe’s policy response has been slow, muddled and – in the mind of many economists and investors – insufficient. Led largely by Germany, the continent’s largest economy, European leaders have combined financial assistance with binding measures to reduce government debt levels, through tax rises, spending cuts and structural reforms.

The problem with this approach, some economists believe, is that these ‘austerity measures’ are withdrawing money from the economy in a time of recession, thus making matters worse. Debt levels are not shrinking, but economies are.

As a result, a growing number of European leaders are calling for a relaxation of austerity rules and implementation of additional measures to stimulate economic growth. To address the debt crisis specifically, some leaders are calling for the establishment of ‘eurobonds’.

These bonds would spread the liability for an individual country’s debt across the eurozone as a whole. Borrowing costs for ‘risky’ countries, like Greece or Spain or Italy, would be brought down if their debt was backed by strong economies such as Germany. The problem is that Germany, and other Northern European nations, are understandably reluctant to put their own credit at risk for the sake of their profligate neighbours to the south.

Until European leaders are able to find some sort of compromise, the global economy will remain in a perilous state. Europe’s leaders will meet next week for another summit on the situation. Markets will be watching their actions closely. Time is running out.

Finance Minister Pravin Gordhan expressed the frustration of many earlier this week: “There’s no doubt the downside risks have been increasing as we see Europe moving from one point of non-resolution of their problems to another point of non-resolution.”

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    • http://www.sane.org.za Yaj

      @ Matt
      A decent article up to a point.
      How did we get here ?
      1. debt-based money system and fractional reserve banking
      2. Bretton -Woods agreements and the USD as reserve currency
      3.Scrapping of the gold standard by Nixon in 1971
      4. Fiat currencies and deregulation
      5.Thatcher-Reaganism and the financialisation of the economy
      6. Derivatives (now a 1.5 quadrillion USD debt bubble)
      7. Greenspan and the blowing of huge asset bubbles
      8.subprime lending, ninja loans, mortgage securitisation, robo-signing, ARMs, credit default swaps and the Housing bubble
      9. Repeal of the Glass-Steagall Act by Larry Summers et al 1999
      10.Peak Oil and the oil price spike pricking the housing bubble 2008
      11.Collapse of Lehman brothers
      12 The bail-outs of the banksters at the expense of taxpayers 16Trillion US$ and counting.
      13 Now the collapse of the Eurozone with bailouts for the banksters and austerity for the people.

    • bernpm

      We all concentrate on the Euro economy but the US economy has gone from:
      (1) current account balance US in 1960 (+2.824 million US) to 2006 (- 811.477 million US) and
      (2) trade balance from 1960 (+3.508 million US) to 2006 (-758.522 million US).

      source: http://www.globalpolicy.org/socecon/crisis/tradedeficit/tables/trade.htm (dated: 2007/08/05)

      I do not have comparative figures for the Euro conglomerate on hand, if at all available from the previous different countries in East and West Europe.
      Other than downgrading individual EU member countries, the US rating agencies have given very little grading information on US banks, various US states or the US.

      The IMF has also been very quiet about the US’s financial solidity.

      What would be the consequences if the Euro collapses, the EU falls apart and all countries cancel their bonds and start marching on by themselves as they did before? SA will loose the $2 billion it pledged.

      What does one do when a house is dilapidated beyond repair? You flatten it and start building form scratch using as much of the old bricks as you can.

    • http://Thoughtleader Jeremiah Kure

      @Rich Brauer, if i were you, I would start paying attention to the well read @Lyndall Beddy much sooner than later. Also see this latest article from the BBC on DNA clues for Queen of Sheba being traced to the Horn of Africa. http://www.bbc.co.uk/news/science-environment-18526428

    • HD

      @Matt

      Can you please provide evidence that EU political leaders have engaged in sustained austerity measures, significant cuts and structural reforms? Tax increases – yes – politically it is the easiest, but economic studies show the least efficient form of “austerity”. (the best being spending cuts, structural reforms and unchanged/lowered taxes)

      Just because political hacks like Paul Krugman, establishment publications like the NY TImes/Guardian, opposition parties or beleaguered incumbent politicians say so, doesn’t make it so…

    • http://hismastersvoice.wordpress.com/ The Creator

      Why are we blowing so much money we don’t have on a problem that can’t be fixed?

    • http://Bloghome Chris2

      When the Euro was introduced shortly after the turn of the century my amateur criticism was that it removed an important mechanism for correction of imbalances in trade, etc., between individual countries in the european zone. Southern european countries tended to adjust their currencies to keep their competitive edge and they could adjust interest rates independently as well. The inflexible euro brought enormous advantages for e.g. German export to the euro zone and it apparently also brought advantages in terms of infrastructure development to the less affluent countries. That these countries were accruing enormous levels of debt was less evident. Warnings that the Greeks were fibbing the books to fulfill the criteria for membership were ignored. It might be a laugh if all added to a zero sum game, but I doubt whether the elusive laws of economics allow such an outcome.
      Turning to the USA, one has to question whether the valuation agencies that packaged junk home bonds as prime investment material have been taken to task sufficiently. After all, they precipitated the economic mess by fraud. Of course, it can be argued that the debt situation in the Western world was unsustainable in any case and this was the straw that broke the camel’s back…..

    • Peter L

      @Matt
      A fundamental problem with the EMU is that in theory at least, there is a degree of monetary integration, but no concomitant fiscal integration.
      As an Economist, you will know that Monetary and fiscal policy need to be managed in unison , and to support common objectives (full employment, sustainable growth etc).

      A second problem is that the PIIGS countries are over overly indebted – they have been living beyond their means (as the USA continues to do) for many years.
      The medicine that is being prescribed – “bail-outs” and “quantitative easing” (printing money) involve creating MORE debt, and sovereign debt at that.
      Ie the Banks cause the problem, the government and its taxpayers pick up the tab.

      The argument that prudent fiscal and monetary policies – living within your means, AKA “Austrerity measures” cause a downturn in Economic activity thus reducing a country’s ability to service their debt, including their new more expensive debt is spurious in the extreme.

      Of course GDP drops and taxes reduce in a downtrun or recession, making it harder for governments to service debt – budget deficits tend to widen during downturns.
      This argument is looking at the wrong side of the income statement – instead of concentrating on the reduced income (tax revenue), the emphasis need to be on the expenditure side.
      keep the expenditure low, and then when the economy does eventually recover, tax receipts increase (income) and now you have a budget surplus.

    • http://none Lyndall Beddy

      In other words the financial “experts” of the world believed the Dubai Government would back its Developers AND that the USA would back its sub-prime loans?

      Who made these idiots experts in the first place?

      And the USA has been living on increasing credit and inflation, and decresing savings for decades – the rest of the sheep just followed them

      And the political party that gets voted into power is the one that promises to spend the most – so they just borrow it.

    • http://none Lyndall Beddy

      AND all our income earning parastatals have been sold (Sasol, Sappi etc) so now the profits and dividends go OUT of the country as well!

    • david saks

      An African country now sending financial aid to Europe?! I’m surprised that noone’s remarked on how striking that is. I also think we could be forgiven for taking a little bow. Our leaders evidently haven’t stuffed up quite as badly as those of many supposedly more advanced nations

    • Enough Said

      The effects of austerity measures in Germany in the the 1930’s laid the ground for Hitler to come to power. Its good the EU are rethinking austerity, we don’t want a 1930’s German replay in Greece, Spain, Portugal and Ireland over the next 10 years.