Eurozone Crisis in a Nutshell

Posted on May 28, 2012 in GlobeScope

By Abdul Wahid Khan:

Eurozone crisis which started in October 2008 and became worse in 2010 and 2011 is basically debt on some countries which are not able to repay it. Those countries are in short referred to as PIIGS nations and they are Portugal, Italy, Ireland, Greece and Spain. This crisis can has potential to affect millions of jobs, businesses, and lives of people around the world and especially in Eurozone. A scary outcome of this crisis may be that the Euro currency may collapse and the countries may have to think of their own new currencies.

Different governments in the world are in some sort of debt and to reduce it, they share it by selling debt instruments so that they can pay some debt and borrow more money. Those who buy such debt are always at risk. So, there are agencies like Moody’s and Standard & Poor’s which give rating to countries based on their capability to pay returns on debt sold as AAA to be best and BBB to be worst. Recently in this Eurozone crisis, France lost its AAA rating. Critics point out that credit card spending in USA and UK is too high and personal debts are much higher there, so rating agencies should reconsider their criteria for ranking. Euro was launched in 1999 to make lives easy in Eurozone. People from different countries can use same currency whenever they travel in that zone. No need to exchange. It became easy for businesses to make deal in just one currency. It also challenged the dominance of US dollar.

Euro is used by 17 countries and the problem is that they all are not the same. Some are rich like Germany while some are poor like Greece, Portugal, etc. Poor countries contribute too less individually for the GDP of zone as a whole, like Greece contributes only 3 %. Poor countries did two things which have put them into crisis. They borrowed too much cash and they got hit by global economic slowdown. So, now they can’t borrow more money to pay their debts. Managing same currency for so different nations is a tough task for governments and Italy, Greece and Portugal are said to opt out from Eurozone. Generally, governments spend money on infrastructure, facilities, etc. They spend more than they collect in taxes so they have to borrow money. Some countries like Greece borrowed too much money and banks started doubting if it could really pay back. It’s less sustainable and followed a practice analogous to overspending on credit cards. In reality, Ireland was the first to go into crisis than Greece. Various economists say that Greece has its own problems like tax evasion and corruption due to which it is in such crisis.

Different countries buy debt of other countries because they are promised good interest on it. When a bank buys debt, it insures that it will get back its money by some policies fixed by financial institutions. Such institutions are interconnected and it’s not clear how long the chain is. In a way, it involves different countries across the globe and if one country goes bankrupt, and then a far away country may get affected.

As a solution, the countries in crisis are borrowing more money from ECB (European Central Bank), IMF (International Monetary Fund), EFSF (European Financial Stability Facility), and ESM (European Stability Mechanism). ESM is latest and it has funds up to 1 trillion Euros. Countries in crisis can apply to it for funds and it will be functional from June 2012. Some countries have also tried to cut spending but critics say that they have taken it too far which may slow down their economic growth.