The European debt crisis impacts financial institutions and individuals all over the world, not just in Greece, Portugal, and other European nations with struggling economies. When a nation like Greece defaults on credit, or reveals hundreds of billions of dollars in monies owed, it’s enough to send U.S. stock indexes plummeting. When Eurozone nations reach a consensus on bailing out a struggling country or forgiving debt, stock prices rise. It may seem like you need a masters in finance to understand all of the factors and historical context at play in the Eurozone debt crisis, which goes back to pre-war Germany. The basic factors at play in this situation include loose credit conditions in the early 2000s, inflexibility on the part of stronger nations with regard to money policy, global financial insecurity, and borrowing on the part of nations. European nations with the most debt include Greece, Spain, Ireland, and Portugal, but even nations like Italy have been affected.
Historical Context
In the early 2000s, countries borrowed funds for infrastructure, development, and other projects. Nations like Italy also took on massive debt through excess government spending, directly in violation of Eurozone treaties. As the global economy weakened after the 2008 U.S. financial crisis, credit was suddenly hard to come by. Debtor nations needed to pay back the money owed, but their own economies were weak.
To gain EU inclusion, countries like Greece and Ireland had to bring their finances in line with those of stronger nations like France and Germany. Once countries did this, they switched from their own currency to the euro, and lost the ability to print their own currency. By printing currency in times of debt, countries cheapen their exports, which make trade more attractive. As trade increases, they gain back some of the lost money, returning to equilibrium. In the Eurozone, countries cannot print their own currency, so when they default on loans, they look to other European nations for help.
Germany is in charge of the European central bank, and has strict rules in place regarding inflation, which can occur when countries print their own currency. As inflation rises, money becomes worth less and less. Hyperinflation in post-World War I Germany caused money to be so worthless that some used it as wallpaper. Many Germans believe this hyperinflation laid the groundwork for the rise of the Nazi party. Today, Germany has the power to print more currency from the European Central Bank, but remains understandably rigid in its resistance to do so.
Solutions
The EU created an agency called the European Financial Stability Facility, which can issue bonds to weak member nations in times of insecurity. This boosted stock prices worldwide, as people thought the crisis in Greece might not spread. To date, the EFSF has helped Ireland and Portugal stabilize their economies. Additional so-called “rescue funding” agencies have been created to help the Eurozone support struggling member nations in times of global or national insecurity. Through these actions, the European nations have been able to reduce the debt in many struggling countries, veering away from the edge of catastrophe. In late 2011, the Eurozone leaders agreed to underwrite half of Greece’s debt, a measure that caused Greek leaders to consider a referendum on the measure. Despite Greek threats to withdraw from the EU and return to the drachma, Greece agreed to the referendum. A second bailout in 2012 helped further alleviate Greece’s debt. To learn more about individual actions taken from 2010-2012 to address the financial crisis, view the interactive timeline at the Wall Street Journal.
As European nations have gained a handle on the debt crisis, some have started to wonder if the financial problems have come to an end. Recently, the European Central Bank’s president proclaimed the debt crisis over. Several market indicators give investors confidence, including five straight months of increased confidence in Germany’s trading volume. While indicators like this suggest increased global confidence is returning to the Eurozone, there are still financial troubles. In particular, larger nations like Spain have unresolved debt. While Spain’s government has taken deficit-reducing measures, the country still owes money it can’t repay without significant growth in GDP, growth that remains elusive in the case of continued aversion towards simulative government policy.
Catch-22
There are those in the highest levels of European banking who believe that the worst has passed, and that the European nations now have a better handle on how to respond to financial problems going forward. This hopeful mindset is currently viewed by some as good news not only for European nations, as USA Today indicates, but for the U.S. stock market, which is tethered to the health of the global economy. However, with the European Central Bank averse to any sign of inflation, a condition considered useful in moderating stability in sluggish fiscal periods, and the major European lending powers intransigent in their insistence on continued austerity policies – policies that historically seem to have only worsened recoveries – politics may be trumping long-term economic prospects, setting up conditions for a collapse in Europe within the year.