Eurozone Crisis: Causes, Structure, and the Future of the Euro

Introduction: The Eurozone Under Pressure

The Eurozone is facing a crisis on several fronts. The most pressing of these is Greece, which is heavily indebted to other Eurozone countries, creating a severe budget crisis (Raman, 2011). As the risk of default on Greek sovereign debt increases, it puts downward pressure on the value of the euro. Other nations within the Eurozone are more or less obligated to back Greek debt in order to salvage the integrity of the currency. While Greece is a significant problem, the currency would not be considered in a state of crisis if Greece were the only concern. The reality is that many peripheral Eurozone countries are in various states of financial disarray — Spain, Italy, Portugal, and Ireland all have serious problems (Raman, 2011). Spain and Italy are particularly troubling because they are too large to be bailed out by the wealthier Eurozone economies. This paper outlines the antecedents and implications of the Eurozone crisis, beginning with the creation of the Eurozone and continuing through an analysis of its structure and future.

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 influenced by liberalization and a new spirit of cooperation. The Common Market was the first step, bringing multiple nations together to reduce customs barriers and 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 a politically united Europe could avoid the devastating conflicts of the first half of the twentieth century. Thus, while public skepticism about European integration has occasionally surfaced, the idea has remained politically popular over the past six decades.

The creation of the euro as a currency for the EEC was a natural extension of the substantial trade liberalization that had preceded it. That liberalization is believed to have had a significant impact on economic development in Europe by streamlining the different regulations that businesses faced when operating across many nations. A common currency extends that logic by eliminating currency exchange rate risk. For nations with major currencies — Germany and France in particular — this risk had already been relatively low; for smaller nations the benefit was more pronounced. By 2002, the euro was in place, with 12 nations in the EU adopting the currency; the United Kingdom, Sweden, and Denmark abstained (NPR, 2010).

The Treaty of Maastricht was signed to establish not only which countries would join the Eurozone but also the terms for future members. The treaty obliged new nations joining the European Union to adopt the new currency, provided they met certain economic criteria. As the EU expanded, so too did the Eurozone. Aside from Greece, however, all of today's crisis countries were original euro members. A handful of small, non-EU states have also adopted the currency. In its early years, the euro was highly successful and began to compete with the American dollar as a global reserve currency.

Greece and the Escalating Debt Crisis

Greece was supposed to be one of the original euro countries but was forced to delay entry prior to the introduction of the currency because it had no hope of meeting the required economic criteria (BBC, 2001). Inflation was a particular problem. When Greece eventually joined the euro, its participation was popular domestically, though concern existed because Greek inflation rates and public borrowing levels were still higher than those prescribed in the Treaty of Maastricht. Greece was nonetheless admitted, making the decision more political than economic. At the time, the EU was in a period of expansion, and its leaders wanted to demonstrate to candidate nations that genuine effort to meet the Maastricht criteria would be rewarded with some leniency (BBC, 2001).

The reservations many held about Greece a decade earlier proved well-founded. In the wake of the global economic downturn, the high levels of public borrowing in Greece created a budget crisis. This resulted in markets pushing interest rates on Greek debt higher, precipitating a negative feedback loop: higher rates made it harder for the Greek government to service its debt, which in turn spurred even higher rates. Greece became the most critical crisis point for the euro, as other Eurozone nations were compelled to bail it out to prevent a Greek default from undermining the currency's value.

The crisis escalated significantly in the months leading up to this paper. The Greek government spent much of the crisis enacting stern austerity measures in an attempt to bring its budget toward balance and avoid sovereign default. From the perspective of ordinary Greeks, however, these measures were a source of deep anger. Most independent observers recognized that Greece's problem was not merely excessive spending; it also faced a significant revenue shortfall resulting from loose tax laws and poor enforcement. This produced widespread tax evasion, particularly among the country's elite, making fiscal evasion a deeply embedded cultural phenomenon (Surowiecki, 2011).

Politically, France and Germany — the latter especially — hold the most influence within the Eurozone and have driven the response to Greece. In October 2011, Eurozone leaders struck a deal with Greece's major creditors to write down 50% of that nation's debt. The deal nevertheless created a political crisis within Greece, in large part because it did not address the revenue side of the budget problem. The instability caused by the deal raised questions about its feasibility, and economic complications emerged as well. Banks across Europe began moving toward demanding higher rates on sovereign debt for all Eurozone countries, because conventional methods of hedging risk appeared inadequate given the threat of a euro breakup (The Guardian, 2011). These concerns were underscored by a failed debt auction in Germany — the Eurozone's strongest member — which functioned as an effective vote of no confidence in the currency union as a whole (Gow, 2011).

Conclusion

The Eurozone crisis is reaching a breaking point. The zone's leaders do not appear to fully grasp the extent of the problem, although the failed German bond auction should have made it abundantly clear. The flashpoint for the crisis is Greece, but the problems with the euro are structural and date to the currency's founding. The leaders of the Eurozone are therefore faced with three options. The first is to expel Greece, calming the crisis and giving other problem states more time to work out solutions to their own budget issues. The second is to enact monetary policy with the problem states in mind — a move that might be costly domestically for Eurozone political leaders but would give those states a genuine opportunity to rebuild their economies more quickly. The third option is to stay the present course and eventually allow Greece to default.

Eurozone leaders have spent too long avoiding the revenue issue in Greece, with the result that it is only now being addressed — probably too little, too late. Greece will eventually fall into default. This will precipitate further defaults among the struggling peripheral nations, making it impossible for the stronger Eurozone economies to manage the crisis. The outcome would be the downfall of the euro as a whole: the currency would either be eliminated or major portions of the Eurozone cleaved off, leaving only the strongest northern nations. The market is already beginning to bet that this worst-case scenario will unfold. Eurozone leaders are being sent a clear message and must respond accordingly — by abandoning the philosophical pretense that led them to admit Greece despite knowing it was an economic mistake, and by addressing the problems rationally, either through genuine monetary policy action or a total restructuring of the euro that excludes Greece.

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