So the Euro-crisis is back and at it again. While most governments of the world have transited on from recession and have moved towards graver issues such as ISIS and the Ebola virus, no topic is more heavily discussed in Paris, Barcelona, Athens and Berlin than the Euro-crisis. With growth in the Euro-zone coming to a halt and deflation looming around the corner, one begs to ask the question if a breakup of the 18-member club is a viable outcome.
However, before this question is asked one has to fathom just how Europe got into its current situation. It all started in 2008 when a collapse of the US housing market brought lending of international credit institutions grinding to a halt. This meant that big banks would no longer offer cheap credit to governments or firms. This is not directly a problem if a country is able to finance itself without deficit spending (ie: the money it has to borrow to run itself). However only a fraction of industrialized nations are currently in such a state of equilibrium. The Euro-zone for one, is not a part of this club. With deficit spending ranging from 2% of GDP in the west to 11% of GDP in nations like Greece. It is important to understand that these deficits were only able to be acquired by nations like Greece by the accession to the Euro-zone.
Greece has never been an economically viable state. The government was forced to limit deficit spending due to its poor international recognition prior to the Euro. Greece was forced to lend money at astronomically high interest rates of up to 18%. Joining the Euro meant joining a financial club in which rich nations like Germany and France backed up poorer states such as Greece, Portugal or Ireland. From one day to another, Greece had to only pay 3% interest on its debt. So what did Greece do? It ramped up government spending and increased the external debt to values far larger that 120% of nominal GDP. And so did the other countries in the Euro-zone. But because of the deep integration, this money now rotated, debt accumulated for the other member states of the Euro-zone.
So when lending halted in 2008 nations like Greece and Spain could no longer function. They could not pay their workers due to no money being available since all the money went to paying off interest of the old debt. This problem exploded in the 2010/11 European debt crises. To prevent a total collapse of the Euro-zone the largest and strongest economy of Europe, Germany, agreed to bailout the debtor nations. However this did not come without a price. Germany reluctantly agreed to the bailout package with the pledge that tougher regulations would need to be put in place to balance out the lack of a unified fiscal policy (ie: How much debt is made). This pledge manifested itself in the amendment of the Treaty of Lisbon and the establishment of the “Fiscal Compact” on December 9th.
The Treaty of Lisbon, originally signed in 2007, is a treaty that outlines the fiscal rules of the Euro-zone countries; however, it originally disregarded concrete matters such as deficit spending. The amendment and the subsequent “Fiscal Compact” that were only established under immense pressure from Berlin were to force countries to reform and cut their deficits. To be more concise, all Euro-zone countries would be given a set amount of time to bring their household deficits to fewer than 3% of nominal GDP and their total external debt to fewer than 60% of nominal GDP. So what has happened since then?
The Treaty ended the Euro-crisis for many people. A $440bn emergency recapitalization fund was established under the name European Stability Mechanism (ESM). The Greek economy has since then shrunken by 25% and to government, under huge national protest, has cut its deficit to reflect a balanced budget. So has Spain that recently returned to very positive economic growth even overtaking the former top player Germany in terms of % GDP growth. Ireland and Portugal have already left the ESM and the control of the European Central Bank and have both made positive progress. So what’s the problem?
The problems are no longer the smaller southern nations but the larger economies such as France and Italy. The majority of the Euro-zone is within their allowed deficit boundaries and % GDP debt. However France and Italy are not the major problems. Both are economically very uncompetitive and mostly protected by EU subsidies such as the Common Agricultural Policy. Both have also failed to cut their deficits back under 3% with the French deficit actually growing to 4,8% from the previous 4,3%. While France is just sitting around recording no economic growth for nearly a year now, Italy is far worse. The Country ́s economy has declined thrice in a row and the country’s debt is eating away its ability to function. So why not just bail them out one might ask. The issue is that both Italy and France are regarded as “too big to fail”. Together they are economically larger than Germany and with Germany they make up 2/3 of the Euro-zone GDP. Not even Germany would be able to bail them out.
Another issue is that both countries are unable to reform themselves. France is a social state with the largest social expenditure of any EU state. This means that if the state cuts spending it would have catastrophic consequences. Unions that regularly strike, last seen in a two-week strike of Air France pilots thereby worsening an already bad situation, control both countries. Also the countries seem to not care about their failure to meet Euro-zone requirements. France has been already given more time to get back on track. Firstly it was 2012, then 2014 and now 2017. If the European Commission does not exercise its power, then states like Greece and Portugal might ask why they are still following the rules. So this is where we end up in the current situation.
There are 18 nations, which share a single currency and are dependent on each other. The failure of one could lead to the collapse of all. But yet each government still has the right to make its own fiscal policy and have a budget deficit, decrease taxes and refuse to reform. This brings us to the vital problem of the Euro-zone. There is a united Monetary policy under the European Central Bank but no united fiscal policy but much rather 18 individual ones. This will not work. Either Brussels and Frankfurt have to give up the ultimate power to set taxes and update or change legislature which will essentially create the United States of Europe under a federal system (the best option and the original goal of the Euro-zone anyway) or the Euro- zone is to break up and countries return back to their national currencies led by Germany’s Deutsch-Mark. But with the Euro-zone being economically larger than the US and hence being the largest economy on earth, this would send an economic earthquake through the financial world with apocalyptic effects for not just Europe.
So I will end with stating the following. The majority of Euro-zone countries are playing by the rules and careful progress is being made in Greece, Spain, Ireland and Portugal. Due to the lack of growth, the Euro-area is weakened and the European Central Bank is forced to support this weak economy by giving away cheap money. This is eroding the credibility and value of the currency union, which then leads to more problems when paying back external debt in foreign currencies due to weak exchange rates. With Italy and France being “too big to fail” and local politicians not possessing the will to reform like Greece and Spain, the Euro-zone is permanently paralyzed. Also, Germany, the former paymaster of the Euro-zone has been so fanatical about saving that it will present its first balanced budget since the 60 ́s and therefore be the biggest industrialized nation making no new external debt. This however has crippled economic growth from 1,8% to 1,2%. Many are calling for Germany to invest more and use its financial ability to help the rest of the Euro-zone to recover. However with the economy already recovering and the German model far from having failed, politicians in Berlin and the almighty German Bundesbank will continue to argue on the simplest of statements. If debt has brought us into this mess then why should it get us out of it.
(Photo credit: http://www.aei.org/files/2012/02/14/img-a-twospeed-reaction-to-the-euro-crisis_15071214642.jpg_item_large.jpg)