Volume 12: 2nd Quarter 2010
Panorama:
Global Recovery Concerns Mount Amid Europe’s Debt Crisis
In an effort to support European nations laden with major debt, the European Union (EU) and the International Monetary Fund (IMF) approved creating a nearly $1 trillion rescue fund in early May. The announcement of the rescue fund, including a €110 billion bailout for Greece, came just as fears were escalating that Greece’s debt problems could spread throughout Europe and seriously hamper a global economic recovery.
World markets rebounded slightly following the announcement, but have remained volatile on the fears of the debt crisis in Europe spiraling out of control. Uncertainty on how the EU will move forward raises concerns as many believe mechanisms within the EU will need to undergo reform to become much stricter about countries’ budgets.
German Chancellor Angela Merkel admitted that the package is no more than a band-aid solution to the problems faced by a number of eurozone countries and the solution is greater cooperation in financial and economic policy across Europe to ensure the currency’s long-term stability. Another discussed possible avenue of reform is the ability to “kick out” financially unstable countries from the eurozone.
Greece must impose severe government and consumer tax hikes on top of the belt tightening they have already done. These austerity measures are a condition of receiving the package of rescue loans.
On May 18th, the EU sent its first installment to Greece, €14.5 billion, under the rescue package. This installment, along with the €5.5 billion Greece received from the International Monetary fund, will help refinance almost €9 billion in loans maturing May 19th.
Greece, like most countries, depends on borrowed money to balance its books. With tax revenues falling and welfare payments rising, borrowing can be difficult to secure. Investors have lost confidence in the Greek government’s ability to cover its debt and demand higher rates of interest to offset the risk they won’t get their money back. The credit rating agencies downgraded Greek government debt to junk status. This escalated the cost of borrowing and essentially canceled Greece’s international overdraft facility. This meant Greece was unable to meet any short term debt. Faced with bankruptcy, Greece reached out to the EU and the International Monetary Fund for support.
Despite the massive bailout, the Euro fell 12% the week of May 10th and hit a four-year low May 17th. This crisis has damaged the perceived stability of the Euro and investors will be watching closely to see if the EU will be able to keep the debt crisis from damaging Europe’s economy.
European Union: At a Glance
The European Union (EU) is an international organization comprising 27 European countries and governing common economic, social and security policies. The EU was created by the Maastricht Treaty, effective on November 1, 1993, and was designed to enhance European political and economic integration by creating a single currency (the euro), a unified foreign and security policy and common citizenship rights.
The Maastricht Treaty formalized plans to replace national currencies with a common currency managed by common monetary institutions, creating the independent European Central Bank to oversee monetary policy.
The treaty defined a set of criteria that specified the conditions under which a member would qualify for participation in the common currency. Countries were required to have annual budget deficits not exceeding 3 percent of gross domestic product (GDP), public debt below 60 percent of GDP, inflation rates within 1.5 percent of the three lowest inflations rates in the EU, and exchange-rate stability.
Several countries failed to meet the criteria; however, 11 countries (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal and Spain) adopted the euro on January 1, 1999. Greece failed to qualify initially, but was admitted to the euro in 2001. Denmark, Sweden and the United Kingdom chose not to participate and did not adopt the euro. Currently, 13 countries have adopted the euro as their currency, including Greece and Slovenia.
In creating the euro, the EU hoped to establish a more stable European economy that would foster competition and opportunity for businesses and markets, improve economic growth across Europe and create a stronger European presence in the global economy and develop a more politically unified Europe.
All nations that operate under the euro system must have the same interest rate. This has created strains on some economies. If its economy slows, the government cannot lower interest rates to stimulate growth. All European nations have not performed equally economically despite using the same currency, illustrated by the recent debt crisis affecting Greece, Portugal and Spain, among others.
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