Ten Things You Should Know about the Euro Crisis - dummies

Ten Things You Should Know about the Euro Crisis

By Julian Knight

The Euro crisis is a complex tale of politics and economics. Potentially, the fate of millions of jobs, life savings, and even some European democracies could hang on what will happen over the coming months and years in the Euro crisis. Here are some facts about the Euro crisis that you’ll want to consider.

Ireland was the first to falter

The Euro crisis has been rumbling on for a couple of years now as the number of countries being perceived as having a major debt problem has increased. Contrary to popular opinion, the first country to slide into crisis wasn’t Greece but Ireland. Throughout the 1990s and 2000s, Ireland had a booming economy, but it relied on massive levels of personal debt and an overinflated housing market. So when the global financial crisis hit, the Irish were particularly hard hit. Housing prices plummeted and banks stopped lending. The country rapidly fell into recession and the government suddenly needed to borrow much more to keep going. Then the Irish government slashed public sector spending, but still couldn’t pay its bills. As a result, the U.K. and wealthier members of the Eurozone have bought Irish government debt to help support the troubled Emerald Isle.

The power of the ratings agencies

Governments around the globe issue trillions of dollars of debt each year. This debt is bought by private investors, financial institutions and pension funds. But how do you know good government debt from bad? That is where credit agencies like Moody’s and Standard & Poor’s step in: They assess government debt for its safety and give it a rating (AAA being the safest while BBB is the weakest). Many have criticized the ratings agencies for being harsh on Eurozone countries as a strong economy like France recently lost its AAA rating.

The crisis could spread to the U.K.

As of this writing, the UK may be as a safe haven to international investors, but it may not last. In 2011, the U.K. government borrowed more than the Greece, and its economy is still sluggish. Meanwhile, the Eurozone accounts for the majority of Britain’s overseas trade and many British banks hold billions of government debt from Eurozone countries. As a result, Britain is threatened by the Eurozone crisis.

Greece’s problem is bigger than Euro membership

Nearly every economist has their own crazy story about the Greek economy (for example, there are only a handful of people registered as millionaires for tax purposes in Greece but 250,000 private swimming pools). Tax evasion and corruption in the public sector are endemic in Greece. The Greek government finds it impossible to collect the taxes that it needs to keep a lid on public spending. Membership to the Euro is preventing Greece from devaluing its currency to make exports cheaper and to increase tourism.

Hedge funds may hurt the economy even more

The Eurozone crisis has sparked several panics on global stockmarkets. Part of this panic has been blamed on hedge funds. These investment vehicles use incredibly complex deals and trade huge amounts in the blink of an eye — all with the big idea of producing substantial returns for their backers. Hedge funds trade such huge amounts of shares and currencies that their constant selling and buying can create panic an uncertainty on global markets. The French president Nicholas Sarkozy has condemned the Hedge fund industry as a threat to the Eurozone and global economy.

Germany is the key player in the Eurozone

With Europe’s biggest population, economy, and healthy government finances, Germany is the powerhouse of the Eurozone. No wonder, therefore, that other members of the Eurozone look to Germany for help. However, the German people back the continuation of the Euro, but they do not want to spend their hard earned money bailing out the weakest links in the Euro.

Debt levels in the U.S.A. and U.K. are higher than the Eurozone

Because of Britain and America’s addiction to credit cards and borrowing to buy property, personal debt levels are actually higher in these countries than the Eurozone. Your average French, Italian, and even Greek person are far less indebted than most Brits or Americans. This has prompted some observers to suggest that the ratings agencies got it wrong to give France a lower credit rating than the U.K.

The global financial crisis helped cause the Eurozone’s current problems

The final cost of the global financial crisis of 2007 and 2008 has been estimated at $3 trillion. That’s a mind boggling sum and much of it was funded by governments around the globe borrowing in order to pump money into their banks, which were on the edge of collapse. At the same time, economies around the world fell into recession and tax revenues collapsed. A big financial black hole was created and it still hasn’t been filled — if anything it’s getting worse.

The European Stability Mechanism might come to the rescue

The ESM was designed as a bailout fund for any Eurozone government which can’t get investors to buy its debt. Basically, Eurozone members will be able to apply to it for loans. Anything up to 1 trillion Euros will be in the ESM — with nearly half of the money coming from Germany and France. It’s supposed to be up and running by June 2012 but this depends on the full agreement of all the Eurozone countries.