The European Union is in crisis, with many members in financial trouble. There are indications that some members may need to leave the Euro and may default on debt entirely. What is going on there? Although you’d need a masters in finance to understand all the complexities, the basics of the crisis are as follows:
In 2009, many experts began expressing concern about the financial stability of the European Union, which is a financial and political union containing 27 independent European countries. Several of the smaller countries in the eurozone have crippling debts to private banks in larger countries. This excessive debt now threatens to degrade the credit rating of the entire Union.
The concerns began with debt in Greece. In the early to mid 2000s, the government of Greece took advantage of the booming economy there and allowed a huge deficit to develop. Greece’s largest industries are tourism and shipping. Both of these sectors were hit hard by the economic slowdown of the last few years. Greece’s debt grew. After a bailout from the EU and International Monetary Fund, this debt included loans of 45 billion euros at high interest rates. As fears mounted that Greece would be unable to repay the debt, the American credit rating company Standard and Poor’s reduced Greece’s debt rating to junk bond level.
Debt in other “PIGS” nations — Portugal, Ireland, Greece and Spain — has also caused concern. In Ireland, overinvestment by banks in shaky real estate investments has left the government with an obligation to cover the bad loans. In Portugal, a combination of overspending and investment bubbles has led to excessive debt. Spain has introduced austerity measures in an attempt to rein in its debt. Ireland’s deficit currently stands at 32.4% of their GDP. Portugal and Spain’s debts are 9.1% and 9.2%, respectively. The debt levels in Italy and Belgium have caused concern as well.
These situations have led to expensive bailouts in those countries. The nations involved have had to agree to controversial austerity measures in order to secure the loans. Critics say that the austerity measures make life harder for citizens, and stifle the growth that will be necessary to climb out from under their crushing debt.
All of this leads to a vicious cycle: because debt levels are so high in these countries, it costs them more to borrow; high interest rates cause debt to skyrocket. Spain, which is the fourth largest economy in Europe, was recently forced to offer 7 percent interest rates in an auction of short-term debt. This is the same rate that Greece, Portugal and Ireland had to pay before their bailouts. By contrast, German bonds yield 1.98 percent interest for their investors.
However, uncertainty has shaken investors in every economy. Germany, long considered a safe haven for investors, was recently able to sell only 3.9 billion euros worth of bonds in an auction out of 6 billion euros in bonds available. Many analysts say this is an indication that the crisis in the European economy is being seen as systemic, rather than the problems of a just a few countries.
Some analysts say that Greece will have to pull out of the European Union and return to their former currency, the Drachma. Failure of the European Central Bank to address crippling debt throughout the EU could lead to a breakup of the union. What will happen now remains a mystery. The situation is precarious, and collapse at any point could cause the entire system to fail.