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July 23, 2012 | by  | in News | [ssba]

Eurozone: A Crisis Explained

As this article goes to print, the Greek government is scrambling to cut €11 billion of government spending. With banks, bonds and German bullies, the ongoing chaos in Europe is not only frightening, but also bewildering. Salient explains the crisis.

To understand the eurozone crisis, you’ve first got to understand Europe. In the years leading up to the crisis, European politics was dominated by two forces: unification and complacency. The paranoia left over from the World Wars and a whole lot of Euro-centric talk had led to a greater desire for pan-European unification of major institutions–like banks. The European Union and their common currency—the euro—are a product of this. Meanwhile, a growing complacency dominated Mediterranean politics. The Spanish allowed the value of their housing to double over a decade, which required enormous debt in their private sector. Then Greece, as a consequence of a whole lot of tax-fraud and the government spending too much, faced public debt of 113 per cent of its GDP by 2008. In other words, they owed way more than they were making.

The Global Financial Crisis quickly ended this apathy; everyone suddenly saw how complacent the Mediterranean was. The global community realised the risk in Greece, Italy and Spain, with credit agencies like Standard & Poor’s lowering those countries’ credit ratings, so as to warn investors of their risks. So creditors, concerned for their investments, demanded higher interest rates.

The higher the interest rates, the harder it is to pay off your debt. So the higher interest rates led to even more debt, scaring credit agencies further This led to still-lower credit ratings and still-higher interest rates. This self-reinforcing cycle has been amplified by the shrinking European economy: as business-people grow afraid of the euro crisis, they became less keen to risk new employees or new investments. So less people get jobs and less people make money. This lowered the Greek tax-take, meaning they have even less cash to pay off all their debt. All of this panic also led to the rise of extremist far-right parties such as Golden Dawn, who openly embrace neo-Nazi iconography, further damaging confidence in the European economy.

Frustrating the euro crisis has been the euro itself. When the United Kingdom was buffeted by the financial crisis, they quickly printed more pounds, which lowered interest rates meaning more people could borrow
and spend. Britain had crawled out of its slump by late 2009. In contrast, when Greece succumbed, it couldn’t simply print more money as it shares its currency with sixteen other countries. One of those countries is Germany, who effectively control the European Central Bank—the institution responsible for printing more euros. Germany suffered nightmarish inflation in the 1920s, leaving their currency worthless. Resultant poverty spurred the rise of the Nazi party. Germany still fears that such hyper-inflation could result from printing money. Despite most analysts dismissing that risk, the Germans have not relented in their stance, and so a monetary solution to the Mediterranean’s woes seems unlikely.

As the situation worsens, Greece defaulting on its loans is almost inevitable. While stimulus packages have been offered, they have been insufficient or carried too many caveats to be effective. Greek default would lead other countries—in particular, Italy—to follow, leading to an evaporation of peoples’ savings as banks and investors face bankruptcy. Such a dissipation of global capital would shatter the world’s economic confidence. The ramifications for New Zealand would be severe. To the Eurozone crisis, the only rational response is fear.


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