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The recent Eurozone sovereign-debt crisis has caused a serious dilemma for not only the weaker economies of the European Union within the Eurozone, but also the stronger ones. Germany, the fifth largest economy in the world and one of the leading EU countries has played a big role in the attempts to solve this crisis, which has put it in a bit of a rough position in its internal political sphere in regards to bailouts for countries like Greece, Portugal and Ireland, and the possibility of future default, yet has also given it an advantage in influencing the economic policies of weaker Eurozone countries who are dependent on bailout money. After many deliberations amongst EU leaders, the European Stability Mechanism (ESM) was approved, which will replace the European Financial Stability Facility (EFSF) upon its expiry in June 2013.
The ESM is meant to safeguard financial stability within the Eurozone and provide assistance to Eurozone member states who are experiencing financial distress. Starting in June 2013, all new sovereign bonds will include a Collective Action Clause (CAC), which will enable creditors to pass a decision, based on a majority vote, to change the terms of payment through application of a standstill, an extension of maturity or an interest-rate cut/haircut in the case of insolvency. The purpose of the ESM is essentially to make default less risky for creditor countries. The problem is that this doesn’t solve the problem of the heavily indebted economies of Greece, Portugal and Ireland and their subsequent affect on other, stronger Eurozone economies such as Germany.
One obvious flaw in the ESM is the fact that it’s just not enough to fix the problem; the fund amounts to €700 billion, allowing for a €500 billion loaning capability, of which each member country will contribute €80 billion each in annual installments that begin in 2013 while the rest will be made through guarantees, direct purchases of government bonds in the primary market or what Wolfgang Münchau has called “callable capital” – when shareholders supply the depleted fund with new capital – a highly unlikely scenario. A mere €500 billion will not cover the debt problem of Greece by itself, let alone that of Ireland, Portugal and other countries teetering on the brink of a debt crisis such as Italy and Spain whose economies simply cannot afford to be further burdened with bailouts for another member state. Furthermore, the ESM fails to tackle some of the most pressing issues regarding the restructuring of the financial systems of all the Eurozone countries that are suffering financially, something that is needed if this crisis is ever going to be settled in the near future.
Eurozone countries with AAA ratings, which are limited to Germany and France, have devised a get-out-of-jail-free card of sorts: the privilege to not have to actually put up the cash for the fund but simply give a guarantee. This will certainly work to their advantage but that at the same time will work toward the demise of the weaker economies, who do not get such a privilege, which seems likely to produce those awful long-run effects that any economics student is so often advised to avoid. It is understandable that Germany and France do not wish to be burdened with the debt of the fiscally irresponsible, if it can be said that simply, yet nonetheless, a customs union/partial economic-union bears with it certain responsibilities and certain burdens, a fact that is always in direct competition with the social welfare programs of the participating countries and thus, will produce a political nightmare for those involved. But if Germany and France allow this circle of debt to continue (Italy backing Spain backing Greece backing Portugal backing Ireland, etc.…) at some point, the bubble will burst and they will be forced to fork over the money and commit political suicide or let the whole Eurozone economy collapse. In the meantime, speculation may kill any chance that the weaker countries have of digging themselves out of the hole, only deepening the problem even more. As an example, Portugal’s government bond rating went from an A- to a BBB after the announcement of the ESM in March, pushing Portugal ever closer to the abyss of dire insolvency.
This does not mean that the ESM is a bad thing. On the contrary, it’s a step in the right direction, but it fails to promote stability amongst Eurozone countries and burdens those who are already on the brink of financial collapse. Countries whose fiscal problems have led them to the point where they must tap into the ESM will be forced to follow “pro-cyclical budgetary policies”, whose tactics of budget cuts and tax increases may not necessarily work to the advantage of the country in question. Another reason that this might cause problems is the fact that a decrease in the money supply of any given country produces a rise in interest rates and a subsequent appreciation of the currency. The last thing that any debt-stricken Eurozone country needs at the moment is an increase in the Euro, which is too strong for many of the weak countries to handle. Of course, the CAC allows for interest rate cuts, but these must be approved by a majority vote, and speculation damages must be taken into consideration; if investors start pulling out due to interest rate cuts, this would also increase the problem.
Another suggestion that has seen some media time has been that of a single European Bond that would replace all national debt in the Eurozone. This prospect was heavily advocated by Wolfgang Münchau in an article for the Financial Times; the flexibility that would be offered by such a mechanism, including the option to be sold and traded on secondary markets could provide an alternative to “cross-country transfers”. Alas, this option might be an even more difficult sell on the internal political scene since combining Germany and France’s AAA bonds with those of the less fortunate is not something that either of the former would be too keen on, and in fact, the idea was shot down by the German Finance Minister in 2009.
Unfortunately, the Eurozone is between a rock and a hard place. Germany’s economy is running strong but the struggling economies of Greece, Portugal, Ireland, Spain and Italy are in dire need of a revamp. The most important thing for the EU to do right now is to jump in to the gritty task of restructuring the failed financial and economic systems of these countries and demand that the government’s of these countries make a serious effort to stabilize, organize and amend their economic and financial infrastructures in a way that will help them to work their way out of the crisis slowly (Buiter et al.). This will be no easy task and will demand the active participation of all debt-ridden Eurozone countries. The future may seem bleak but at some point, the Eurozone countries will be forced to a point where they will have to stop “muddling through”, as Münchau calls it, and take a decisive action. Just what this action may entail remains to be seen.
Nina Michael is in her junior year in the BS in Business program at CUNY School of Professional Studies. Nina has been all over the world and loves traveling; she currently lives between Italy and New York where she works as a professional English teacher and translator. She loves languages, food, coffee, wine and a good book; she is also a first-rate bartender.