Europe and the Euro Crisis

On 11/07/2011, in Economics, by Jordan Wilson

Europe continues to go through its latest financial crisis.

What has gone on and what will happen in the future?

Well, if we knew for certainty what the outcome will be, we would all be billionaires. Or, at the least, we might be running MF Global instead of Jon Corzine and they would not be in Chapter 11 bankruptcy proceedings today.

But we can go through a summary of what went on and where we are at today in Europe. 

Short Explanation

In short, Europe and the Euro are screwed. Hoisted on their own petards.

I can think of better expressions, but this is a family blog.

To flesh that out ever so slightly, there are two underlying reasons why the Euro is in real trouble.

Europe is not a Unified Country

There are significant disparities between Euro-zone countries.

These include such things as: national pride, cultural differences, unique fiscal policies, different social welfare systems, economic conditions, economic and political histories, etc.

As I have written before, the Euro is made up of many different nations. If you ask a Frenchman who he is, he will say French. An Italian is Italian. Outside the Euro elite in Brussels, the average European still sees himself in the context of his country, culture, and history. This markedly differs in my experience with Americans. They see themselves as Americans first, then Californians, Texans, etc.

Of course, the goal of Brussels is to change all this. To move to the point where Spaniards view themselves as Europeans first and foremost. And to shift de facto control in all areas for each country to the European Union itself. If this occurs in the near future, the Euro may be salvaged. At what cost to the inhabitants of individual countries is another story.

The Euro was Fudged From Day One

Fudged I said.

Upon creation of the Euro, there was some creative accounting to ensure that certain countries met the entry criteria. In fact, Greece was already in breach of the Maastricht Treaty (TEU) requirements when it entered into the Euro.

Since inception, there are been numerous countries at numerous times that have breached the ongoing requirements under the initial Stability and Growth Pact (SGP).

This lack of adherence to the rules from day one made the Euro a questionable proposition. The Euro countries continually turning a blind collective eye to breaches over the last 10 years caused further problems.

How can one expect countries to follow the rules, when breaches occur with impunity?

A More Detailed Look at Where Europe is Today

The New York Times offers a nice chart and summary of where Europe is today.

I do not agree with their implication that a large bailout is required. Especially, as is not pointed out in the narrative, when the European Financial Stability Fund (EFSF, i.e., the bailout fund) will itself need to be significantly leveraged to meet its objectives. This just adds to the risk of the bailout.

The Times also offers an interactive chart that allows you to scroll your mouse over the countries for additional detail. I liked the scrolling feature. Kind of reminded me of 3-D films. It is bad enough to watch a horror film in two dimensions. But with the gore coming out at you in a new way, it is ever more fun. Seeing the financial details for the different countries jump right out as I scrolled by really enhanced my squeamishness at the Euro’s future.

Bonus Points

For bonus points, when you do look at a country’s data, quickly compare it to the financial requirements under the SGP. Adhering to the rules are they?

And not just Greece. Portugal has gross government debt (GGD) as a percentage of gross domestic product (GDP) of 106%. Italy is at 121%. Ireland is at 109%. Even the large, stable countries of Germany and France have ratios of 83% and 87% respectively. Under the initial entry requirements of the TEU and the ongoing SGP, the limit is 60%.

Lest you think I cherry picked the data, the mean GGD to GDP ratio for all Euro countries (EA17) in 2010 was 85.1%.

And no, 2010 was not a special year, where the ratios were skewed by world events. In 2009, the mean ratio for the EA17 was 79.3%. In 2008, 69.9%. In 2007, 66.2%. And those are the average ratios of all the EA17 nations.

And by the end of 2010, 12 of the EA17 countries exceeded the 60% limit. Yes, 12 out of 17 countries breached the limits. So one or two countries did not move the mean either.

What about fiscally prudent countries like Estonia, with its paltry ratio of 6.6% (yes, 6.6%)? I could weep for them. Or perhaps sell them a used car or two.

What Will Happen Next?

A very good question. And a hard one to answer at this time.

Certain historically sharp investors (see Jon Corzine) have already got it wrong.

Some believe that a financial bailout is the answer and will get the Euro countries back on track. I do not share this view of the world.

Unless Euro countries make some very difficult economic decisions that address the underlying issues, any bailout will simply be a bandaid covering a wound that never heals. In the case of Euro countries the underlying issues are noted above as differences between the individual countries.

I think that Brussels must take control of each country’s decisions and consolidate them under one, unified approach. This means that the concept of countries in Europe would disappear as they exist today. Italy, Germany, etal., would become states within Europe. How this impacts each country, including the control they must cede to Brussels, is an interesting issue.

Second, money does not grow on trees. At some point, there will be no one left to lend money. Already China is leery of borrowing more from Europe and the U.S. When China, a communist country, believes that expenditures on social welfare programs needs to be reined in, that says a lot about spending in Europe and America.

Now it is all well and good to abrogate the historic rights of countries and to fundamentally restructure each country. It can be done at the stroke of a pen. And, in my view, most of the political elites in Europe would do so tomorrow.

But the real question is whether average John (or Jean, Giovanni, Juan, Johann) on the street will let these necessary changes occur. I can see the average person happily ceding their nationality if they can continue the current (or better) social welfare system. But not losing both.

We have already seen the demonstrations in Greece. If the necessary steps are taken to control expenditures across all of the Euro countries, it could get messy.

2 Responses to “Europe and the Euro Crisis”

  1. You blog has some great posts. I found it through Yahoo. Keep up the great work!!

  2. Thelma Rodd says:

    Great post, I totally concur. If I may deviate off subject and point out that regardless of having to pay income tax to the federal government and sending our citizens to combat and die in every war, Washingtonians have had no voting representation in Congress and have had to seek acceptance from people they didn’t elect on all legislative and also budgetary matters. That my friends is criminal offense against society, and America. Let’s hope it will change soon. Cheers.

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