Europe Debt Derailment: Daunting the Globe

 | September 03,2012 11:15 am IST

Crisis, as the word drops onto your ears, it instills a sense of urgency and you tend prepare yourself for all those adjectives which will be falling in next, akin to mess, instability, crunch, collapse and so on. That is what this prose is all about, where we are talking about a continent having a population of more than 730 million stuck in a massive crisis owing to various causes such as high government debt levels of various eurozone countries, inability to alter monetary policies due to a common currency, trade imbalances and the loss of faith of investors across the globe.


What happened?
In the early 21st century, the world was experiencing a huge flow of cash on a global scale, with most of the European countries slowly and steadily running into large deficits, while simultaneously the US financial system was gaining rapid momentum, which further allowed banks to use their investors money shabbily in various sovereign and collateral bonds. The ease with which credit was available throughout, led to a financial globalization. Moreover, it was easier for developed countries to borrow money. The members of EU although signed the Maastricht Treaty under which they were obliged to limit their deficit spending, but countries like Greece and Italy were able to disguise their deficit through complex credit derivative structures. The net debt for EU has reached to 89% while Greece alone faces a magnanimous net debt of 173% in 2012 as com-pared to about 90% in 1999.


The vicious cycle kept repeating, as the foreign in-flows in various countries across Europe rose to almost 45% of most of the countrys GDP which was a precursor, but still was ignored. The national and local banks of countries like Greece, Italy and Portugal started expanding and henceforth started growing at about 20% per year. They started giving loans to everyone, but when people they had given loan to defaulted, they fell off the edge. Their large deficit forced the Credit rating agencies like Standard & Poors in the late 2008, to degrade their ratings, which in turn terrified the investors and they started pulling back their money or demanded a higher interest rate over sovereign bonds, which left the countries in larger debt and hence aggravating the derailment process.


How terrible is the mess?
After the agitation caused by the USA across the globe, what the world least needed at this time was a Europe muddle, which has left the common man to think of his future on sale. The sudden collapse of the top banks of USA, like Lehman Brothers, Meriyll Lynch, Goldman Sachs, caused abrupt disruption of cash flow, affecting not only the financial systems globally, but even sectors like manufacturing, insurance agencies, etc. which led to a shrinkage of various other economies.


Moreover, as mentioned before, the out-shooting of process caused by the investors left the countries to starve. Furthermore, the turmoil in Europe has been continuously costing the market in terms of volatility, as the market is on a continuous jump or drop of as high as 5%. Additionally, there were sharp changes in ex-change rates globally. High ex-change meant high investments and vice versa.


Most of the countries initially understated their accounts, to save the fall in their credit rating, but later when exposed there was no escape.

The crisis gained momentum through 2000s, and today has reached catastrophic levels, with Greece being the first one among the EU countries to be exposed in 2008. Rather today, a term PIGS (Portugal, Ireland, Greece, Spain) in correlation with the Euro Crisis. Greece used its sovereign fund to provide heavy subsidiary in its social security program for citizens like early retirement, good pensions, Government aided healthcare, education etc. This was further accompanied with high tax evasions, which forced the Greek Government, had to go on a borrowing spree to finance its expenditure.


Every country has its own story of crisis, and so is the case with Ireland, which followed in next, as instead of engaging itself social benefits, it allowed its national banks to do the trick by giving them a ticket to borrow foreign loans to fund its economys growth. The banks enacted by channeling that money into property market, which later defaulted, forcing the Irish government to take the blame which they could not afford to honor. The Celtic Tiger, a name given to Ireland not long ago due to its fast growing economy, cost investors their confidence and money at the same time.


Spain on the other hands, being one of the biggest among the PIGS in terms of GDP, was seen as a fruitful and safe investment, but risky credit and public debt creation, has left Spain in considerable amount of debt. Situation in Spain may further worsen, if debts which are handled internally, default. A Spain default would have even more disastrous effects as a large number of French, Italian and British investors have lent money to Spain. This could lead to a contagion effect, i.e., a default in Spain would ultimately lead to a default in the France, Italy and Great Britain. Portugal government over the time has encouraged over expenditure and investments in public-private partnerships, leading to a huge bubble within their economy and hence the huge deficit.


The point of concern here lies in the safety net being provided by stronger economies with-in the Euro countries, like Germany and France. Also finally these countries are expected to tap IMF, the lender of last resort.


Measures already in place:
In order to reduce deficits to a maximum of 3% of the GDP, the EU countries have already subjected their people with policies to burn their pockets. Greece has decided to include new property tax and lay off almost 30,000 civil servants on partial pay by the end of this year. Ireland has trimmed off a big chunk of their domestic spending amounting to 4bn Euros. Italy has focused upon high tax rates such as sales tax and wealth tax to accommodate a savings of worth 58.9bn Euros. Spain and Portugal have not been far behind as they have decided to make the rich suffer more by imposing 5% pay cut on them. Additionally, Spain has increased its tax on tobacco to 28%. France has raised corporate tax by up to 5% for high end companies, making them pay more for their fortunes and has simultaneously increased VAT to 7%. Romania and Netherlands have similarly reduced their governmental spending.