EUROZONE CRISIS

If you are not living under a rock there is a high probability that you  have heard of eurozone debt crisis and its resurfacing in 2011. It’s being billed as the Greek Debt Crisis by the media, but intelligent analysts, investors, and traders, understand that it is far beyond Greece. It is the European Debt Crisis. Here we will try and understand the causes and implications of the same.

Throughout the 90’s Greece historically faced high rates of inflation and extreamly high debts  and growing fiscal deficits because of its inefficient monetary policies ,so it was no surprise that with the formation of eurozone and floating of the euro as currency in late 90’s  Greece  and other European nations in similar condition like Portugal, Italy, Spain etc . were eager to join the club because:

1.    All member countries would use euro as the currency which would have a common  central bank (ECB in this case) backed by strong european economies such as France and Germany  which meant borrowing money from other nations  would be cheaper  for countries such as Greece (using euro) than using their current currencies (typical interest rate  on Greek drachma was  18% because of reasons stated above)

2.    The grand idea was  that  the  struggling european economies  could borrow  at cheap rates in order to economically develop their countries in a responsible manner. This would help them close the gap with stronger countries like Germany and France, and then all of Europe would grow more powerful.

So by 2000 Greece was allowed to join the EU and use euro as currency (though there were allegations that it cooked up  the figures to meet the stringent euro criteria) .on entering  of course Greece ( so did nations like Portugal, Spain, Italy, and Ireland )  borrowed money at very cheap interest rates (close to 3% as compared to 18%) but it is what they did with that money made things worse. Instead of govt expenditure on infrastructure  building and capacity generation  and paying up of accrued debts (as intended) the country went on a spending spree the wages of public sector employees nearly doubled, and it continued to fund one of  most generous pension systems  coupled with tax evasion endemic among the Greek  populations  resulted in non- payment of loans and debt spiraled to about  €300 billion, more than the entire value of its annual GDP.

That’s just one country take the example of Spain  which had the biggest housing bubble in the world.  Spain now has as many unsold homes as the United States, even though the US is six times bigger. Most of these new homes were financed with capital from abroad.

Thus these countries have spent so much money and developed such irresponsible fiscal agendas that they are now having trouble paying back all those loans. To make it worse, investors are now demanding more yield in order to hold the debt of these countries. That is making it even harder for the PIIGS (Portugal, Italy, Ireland, Greece, Spain) to pay back the money they owe resulting in a sustained crisis situation.

By Suddhasheel Bhattacharya