Eurozone Crisis The Eurozone Is Currently Facing Term Paper

Length: 10 pages Sources: 4 Subject: Economics Type: Term Paper Paper: #77914167 Related Topics: Spain, Bailouts, Ireland, Financial Crisis
Excerpt from Term Paper :

Eurozone Crisis

The Eurozone is currently facing a crisis on a number of fronts. The most pressing of these is Greece, which is heavily indebted to other Eurozone countries, creating a budget crisis in the country (Raman, 2011). As the risk of default on Greek sovereign debt increases, this puts downward pressure on the value of the euro. Other nations within the Eurozone are, in order to salvage the integrity of the currency, more or less obligated to back Greek debt. While Greece is a significant problem for nations within the Eurozone, the currency would not be considered to be in a state of crisis if Greece was the only problem. The reality is that many peripheral Eurozone countries are in various states of financial disarray -- Spain, Italy, Portugal and Ireland all have problems (Ibid). Spain and Italy are in particular a problem, because they are too big to be bailed out by the wealthier Eurozone economies. This paper will outline the antecedents and implications of the Eurozone crisis, beginning with the creation of the Eurozone and continuing through an analysis of the Eurozone's structure and the future of the Eurozone.

The Common Market and the Creation of the Euro

The philosophy behind the Euro began with the creation of the European common market. After World War Two, the political development of Western Europe was heavily influence by liberalization and by a new spirit of cooperation. The Common Market was the first step, as it brought multiple nations together to reduce customs and to streamline business regulations. The Treaties of Rome created the European Economic Community (EEC), which would later lead to the creation of a European parliament (NPR, 2010). Philosophically, this movement was driven by a spirit of partnership and the idea that if Europe was united politically the devastating conflicts of the first half of the 20th century could be avoided. Thus, while there is occasionally public skepticism about European integration, the idea has remained politically popular through the past sixty years.

The creation of the euro as a currency for the EEC was a natural extension of the substantial trade liberalization that had preceded it. The trade liberalization is believed to have had a significant impact on economic development in Europe because it streamlined the different regulations that businesses would deal with when attempting to do business across Europe's many nations. A common currency extends that theory by eliminating currency exchange rate risk. For nations with major currencies -- Germany and France in particular, this risk was lower than for smaller nations. By 2002, the euro was in place, with 12 nations in the EU adopting the currency, the abstainers being the United Kingdom, Sweden and Denmark (NPR, 2010).

The Treaty of Maastricht was signed, not only noting which countries were to join the Eurozone but what terms would be set for future nations. The treaty obliged new nations joining the European Union would adopt the new currency. These states would be allowed to join the Eurozone if they met certain economic criteria. As the EU expanded, so too did the Eurozone. However, aside from Greece all of today's crisis countries were original euro countries. There are a handful of small, non-EU states that have also adopted the currency. In its early years, the euro was highly successful, and has begun to compete with the American dollar as a global reserve currency.

Greece

Greece was supposed to be one of the original euro countries, but was forced to leave the Eurozone prior to the introduction of the currency because it had no hope of meeting the economic criteria (BBC, 2001). Inflation in particular was a significant problem. At the time that Greece joined the euro, the country's...

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There was also concern at the time, because Greek inflation rates were still higher than those prescribed in the Treaty of Maastricht, as was the level of public borrowing. Greece was admitted, therefore, even though the country did not meet the basic criteria for being allowed in the Eurozone. The decision to allow Greece into the Eurozone therefore, was more political than economic. At the time, the EU was in a state of expansion, and its leaders wanted to show the new EU nations that if they at least tried to meet the Maastricht criteria, there would be some leniency with respect to joining the Eurozone (Ibid).

The reservations that many had with respect to Greece ten years ago were well-founded. In the wake of the global economic downturn, the high levels of public borrowing in Greece created a budget crisis in that nation. This resulted in markets pushing the interest rates on Greek debt higher, precipitating a negative feedback loop where higher rates made it harder for the Greek government to pay down its debt, which in turn spurred even higher rates. Greece became the most important crisis point in the future of the euro, because other Eurozone nations would be forced to bail out Greece in order to keep Greek default from hurting the value of the euro.

The crisis has escalated in recent months. The Greek government has spent the better part of the crisis enacting stern austerity measures in an attempt to bring its budget into balance, or at least something that avoids default on its sovereign debt. From the perspective of the average Greek, however, these measures are a source of anger. The problem as most independent observers understand it is that Greece does not just have a problem with excessive spending, it also has a significant revenue problem as the result of loose tax laws and shoddy enforcement of even those. This results in widespread tax evasion, particularly by the country's elite, and the result is a revenue shortfall as tax evasion has become part of the nation's culture (Surowiecki, 2011).

Politically, the major Eurozone nations of France and Germany hold the most influence, the latter in particular. These nations drive the interests of the Eurozone, and have done so with respect to Greece. In the October 2011 the Eurozone leaders struck a deal with Greece's major creditors to write down 50% of that nation's debt. The deal, however, created a political crisis in Greece, in large part because the deal did not address the revenue side of the nation's budget problems. The instability that the deal has caused in Greece has raised questions about the plan's feasibility, and there are economic issues with the plan as well. Banks in Europe are apparently moving towards demanding higher rates on sovereign debt for all Eurozone countries, because the past methods of hedging risk seem to be inadequate given the risk that the euro breaks up (The Guardian, 2011). These concerns are highlighted in a recent failed debt auction by Germany, which is the strongest member of the Eurozone. This auction failure is essentially a vote of no confidence by the banking community in the entire Eurozone (Gow, 2011).

Other States

As noted, if the Eurozone's issues were confined to Greece the problem would not be a problem. But there are several Eurozone states in various degrees of financial trouble. The key to this is that Greece -- or any single one of the other Eurozone nations -- could be bailed out by the largest and most stable Eurozone partners. When the problems are widespread among other countries, such bailouts become impossible. Among the other nations in trouble are Ireland, Spain, Portugal and Italy. Ireland had a strong budget position prior to the global economic meltdown, but chose to blow its budget bailing out its incompetent banks. Spain also had a surplus, but that country's economic strength was based on a strong real estate sector that has since tanked. Portugal's problems are similar to Spain's, while Italy also has a high level of public debt. The problem for each of these nations is not so much their debt level, but their ability to borrow. As confidence in these nations decreases, their borrowing rates increase, initiating a negative feedback loop that leads eventually to default. Thus, there is a degree of interrelationship between the debt issues in these countries. As the risk of one default increases, this puts upward pressure on sovereign debt yields for the others as well. Technically, even a nation like Germany must pay more on its debt, but the German economy is strong and its borrowing rates low so the impact does not threaten to reach crisis levels.

Thus, while Greece is a singular unique case in the crisis, the near-crisis situation in the other peripheral countries is more dangerous to the future of the euro on aggregate than any one individual nation could achieve on its own. Greece would merely be the tipping point, and there is the risk of a cascade effect once Greece goes into default, with the other peripheral nations following suit one by one, the crisis intensifying each step of the way. While solving the Greek problem can…

Sources Used in Documents:

Works Cited:

BBC. (2001). Greece joins Eurozone. British Broadcasting Corporation. Retrieved November 23, 2011 from http://news.bbc.co.uk/2/hi/business/1095783.stm

Gow, D. (2011). Shock as €6 billion German bond sale ends in failure. The Guardian. Retrieved November 23, 2011 from http://www.guardian.co.uk/business/2011/nov/23/eurozone-doomed-without-central-control-barroso

Krugman, P. (2011). Romantic views threaten Europe. Houston Chronicle. Retrieved November 23, 2011 from http://www.chron.com/opinion/outlook/article/Romantic-views-threaten-Europe-Paul-Krugman-2281150.php

NPR. (2010). A brief history of the EU. National Public Radio. Retrieved November 23, 2011 from http://www.npr.org/templates/story/story.php?storyId=128389419


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