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Europe: economic tragedy? « Previous | |Next »
October 26, 2011

Europe is facing a banking crisis as well as a sovereign debt crisis. This has been developing for two years. The euro is a shared currency outside a fiscal union – and as a currency shared by fiscally independent member-states it has generated vicious negative feed-back loops between sovereigns and banks.

The legacy of the global financial crisis in 2008 was a sovereign debt crisis in parts of the eurozone, and a banking crisis across the region as a whole. The two crises have fed on each other ever since, with weak sovereigns undermining confidence in banks and vice versa. The greatest threat to the eurozone is that this vicious feedback loop spins out of control.


Three crises have intermingled and reinforced each other: Greece, Ireland, Italy, Portugal and Spain face crises of excessive debt (public and private); those same countries suffer from low economic growth; and much of the European Union is afflicted with a banking crisis.

Much of the debt owed by Greece, Portugal and perhaps others will have to be written off, and that in turn will require a massive recapitalization of European banks (by €200-300 billion, IMF figures suggest). Then the markets will have to be calmed with a big bazooka aimed on them. Behind Europe's sovereign debt crisis sits Europe's declining economic growth. Without growth, the debt crisis will continue to re-emerge.

Governments will need to recapitalise their European banks (around €100 billion is minimally required); the banks will need to take a haircut (40-50%) on their bad debts in Greece; the firepower of the eurozone bailout fund (European Financial Stability Facility [EFSF]) will need to be increased (to €2tn?); the European Central Bank will need to become a lender of last resort to stabilize the various economies; and Italy and Greece will need to live up to their promises to get their debt and budgets in order.

Italy is the key. It has the third largest debt market in the world, well over €1trn of outstanding debt. Investors, fearing a possible default, are demanding high interest rates on Italian debt. And these high interest rates, by raising the burden of debt service, make default more likely. They'll do just enough to buy themselves more time. Italy is unwilling to engage in reform, preferring the no growth option.

So far it doesn't look as if the European political class is getting on top of the problem. Paul Krugman says

It’s a vicious circle, with fears of default threatening to become a self-fulfilling prophecy. To save the euro, this threat must be contained. But how? The answer has to involve creating a fund that can, if necessary, lend Italy (and Spain, which is also under threat) enough money that it doesn’t need to borrow at those high rates. Such a fund probably wouldn’t have to be used, since its mere existence should put an end to the cycle of fear.

Krugman adds that the problem is that:
All the various proposals for creating such a fund ultimately require backing from major European governments, whose promises to investors must be credible for the plan to work. Yet Italy is one of those major governments; it can’t achieve a rescue by lending money to itself. And France, the euro area’s second-biggest economy, has been looking shaky lately, raising fears that creation of a large rescue fund, by in effect adding to French debt, could simply have the effect of adding France to the list of crisis countries.

Yet, if the European Central Bank were to stand behind European debts, the crisis would ease dramatically. Much of the debt owed by Greece, Portugal and perhaps others will have to be written off, and that in turn will require a massive recapitalization of European banks (by €200-300 billion, IMF figures suggest).

Euroskeptical Britain — it is currently in the EU but not the euro-- is talking about its national interest and protecting the special position of the City of London and its get-rich-quick culture. Many Europhobic Conservatives-- have signed a parliamentary motion calling for a referendum on whether Britain should leave the EU or renegotiate the terms of its membership. These Eurosceptics----Little Englanders-- want splendid isolation and a neo-liberal economy.

The measures are:

(1) the banks would take a 50 per cent haircut on their holdings of Greek sovereign debt. This will wipe about €100 billion off Greece’s near-€350 billion of sovereign debt. In addition there is €100bn of new loans.

(2) the European Banking Authority announced that the EU banks would raise €106 billion of new capital between now and June next year to cover the holes in their balance sheets created by the losses they face.

(3) an increase in the size of the European Financial Stability Facility, which has been trying to put a floor under the bonds issued by the more parlous economies, from €440 billion to one €1 trillion. That’s an attempt to head off any assault by the markets on the next most vulnerable economy, Italy.

What was excluded was the European Central Bank promising to purchase bonds without any arbitrary limit from every solvent but distressed sovereign state. So we fall back to the European Financial Stability Facility with its non existent €1 trillion. This is supposed to be raised by luring in private investors and the likes of Beijing through special vehicles and sophisticated insurance deals, a state-sponsored variety of the antics which occupied the markets before the crash.

The measures will not stimulate economic growth, which is what is needed to help the angry, unemployed citizens. If Europe cannot grow an economy big enough to shoulder its debts, then the crisis will not go away. For instance, Greece is bust, and the harsh austerity plans means that it will have a sickly economy, still mired in debt in nine years' time. That means more social and political unrest to follow in the months and years to come, particularly as the economic recovery will be a long time coming.

| Posted by Gary Sauer-Thompson at 1:53 PM | | Comments (13)


Another long-term problem is peoples’ growing hostility to the EU in general and to the euro in particular. Even if EU leaders can, belatedly, agree on the right policies to save the euro, public opinion may prevent them from carrying out those policies.

At the moment little is being done to boost growth across Europe.

"These Eurosceptics----Little Englanders-- want splendid isolation and a neo-liberal economy."

Populism, nationalism and euro-skepticism are on the rise throughout the EU.In the UK Conservative ministers and MPs are united on one major objective behind the patriotic rhetoric freeing the United Kingdom from servitude in the EU. This objective is abolish all or much of the social and employment legislation (re sex discrimination, equal pay, employment rights) that Europe has given to families and workers in the UK.

The Tories want to reduce such rights to make the labour market "flexible", or in other words, to give employers even more power over their workers.

Gee, how do I comment here without betraying my own ignorance of the esoterica of these things.
I think I get the gist, but am going to sleep on it.
Thanks for another interesting, relevant thread starter, reading of this in the Guardian the other day, the terminology seemed so "Dutch" that I found difficulty in making heads or tails of it.
Am aware that Gary and others have tried to explain this Eurocrisis in the past, but its been like looking at ten ton of sand to be shifted on a hot day, its so much more tempting to go inside, turn the air con on and flick on the tennis.

the Italian government is weak and divided and it is only capable of taking policy initiatives to tackle its fiscal and economic problems when put under enormous external pressure to do so. These initiatives include cuts to the cost of public administration, further pension reforms and a liberalisation of labour markets.

Berlusconi is under huge pressure to finally deliver on spending reforms from fellow EU leaders, and he is struggling to get support from within his own government for such measures.

The Guardian's Business Blog says that:

The French want the eurozone to follow the example of the US Federal Reserve and provide unlimited funds to support troubled European economies. The big bazooka that blasts away fears of contagion and a domino of defaults after a Greek deal should be, says Paris, a commitment by the European Central Bank to buy Italian, Spanish and Portuguese bonds, come what may.

In this way the eurozone shares the pain, and what pain there is will be shunted many years down the road until such time as the loans are redeemed. They could be considered war loans, and paid off over the next 50 or 60 years, just like second world war loans.

Germany is refusing because this ivolves the ECB buying loans with money that is "created" in its Frankfurt cellar. It is as if the ECB has a massive printing press in the bowels of its offices that generates cash with the sole purpose of buying sovereign bonds.

Germany['s position is that they want all eurozone countries to contribute to the insurance fund and spending cuts to deal with the situation.

Italy has a staggering €1.9 trillion ($US2.6 trillion) mountain of debt. There are fears the country may struggle to rollover more than €250 billion of debt that comes due next year unless it can convince markets it is serious about implementing urgent reforms to boost growth and cut debts.

The borrowing costs of Italy's debt are rising fast and the the ECB refuses to commit to continue buying the bonds of troubled eurozone countries to stop the crisis from spreading and to stem the turmoil in financial markets.

the banks have agreed to take a 50 percent loss on the face value of their Greek debt.

"This {Tory Eurosceptic] objective is abolish all or much of the social and employment legislation (re sex discrimination, equal pay, employment rights) that Europe has given to families and workers in the UK."

The Tory Eurosceptics see the crisis in the eurozone as an opportunity to put a wedge between the UK and the EU. In their eyes, the EU is now the sole origin of political and legislative action protecting Europe’s citizens from the excesses of unfettered markets - and it is therefore the enemy.

the measures are enough to buy Europe the time it needs--from the pressures on the weaker sovereign states by the markets--- to put in place the longer term economic and political strategies it requires

The assumption underpinning the bank's 50% haircut on Greek debt is that the Greek deficit can be brought under control.

However, with ostructure was sceptical of this, but even that document was overly optimistic as far as we can see. With the levels of unemployment that Greece continues to suffer – levels that will probably rise in the near future – its budget deficit are here to stay.

Yes, well, they had a segment on Latteline last night that ended with an interview with a Greek economics professor who drew a grinning Tony Jones to remark on this fellows unlimited scepticism as to the Euro crisis, I think for reasons already expressed by Gary et al, here.

Yanis Varoufakis, the Professor of Economics at Athens University, says on Lateline, that nothing much has happened:

I read very carefully every word that the communiqué included and I didn't see anything other than a definition of the areas which the European Union considers to be important.
When it comes to their proclamations of what they're going to do about these areas, about these problems that are threatening the euro system with imminent collapse, I saw nothing there which contained detail, and of course we know that it is in the detail that the devil resides.

The European politicians are hoping that in the next few weeks, probably months, something of a rational plan will emerge magically out of the mess they found themselves in.