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Page 1: European Crisis Final1

Mayank Gandotra – 11PGDM090

Nikhil Pawa – 11PGDM096

Srinija Appalaraju – 11PGDM113

Sumit Dua – 11PGDM116

Venugopal Kankani – 11PGDM119

Euro Crisis

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ContentsAbstract.......................................................................................................................................................4

Keywords.....................................................................................................................................................5

European Crisis............................................................................................................................................6

Going back to the origin..........................................................................................................................6

How did the Euro benefit them?.........................................................................................................6

Situation in Greece..................................................................................................................................7

Situation in Spain.....................................................................................................................................7

Why countries are not defaulting?..........................................................................................................7

The vicious cycle......................................................................................................................................8

The other countries - interconnection.....................................................................................................8

Getting out of Euro?................................................................................................................................9

Measures taken to prevent the crisis........................................................................................................10

Bailout Package.....................................................................................................................................10

Emergency Parachute............................................................................................................................10

European Stability Mechanism..............................................................................................................11

European Central Bank (ECB).................................................................................................................11

Savings package by the Greek Government..........................................................................................11

Proposed 6th measure – Euro Bonds......................................................................................................11

Was the Euro a good idea?........................................................................................................................13

Maastricht Treaty..................................................................................................................................13

Price Stability.............................................................................................................................13

Fiscal Prudence..........................................................................................................................13

Successful EMS Membership.....................................................................................................13

Interest-Rate Convergence........................................................................................................14

How do these benefits of the euro arise?..............................................................................................15

Benefits worldwide................................................................................................................................15

Realizing the benefits............................................................................................................................15

Will the Euro zone disintegrate in the near future?..................................................................................18

Profligacy Diagnosis...................................................................................................................................22

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Political Impact..................................................................................................................................24

Economic Impact...............................................................................................................................24

Germany :Central to the solution of the Euro crisis...................................................................................25

Germany’s History in Europe.................................................................................................................25

Germany’s Current Role and Actions.....................................................................................................26

Cost of Breaking Up...............................................................................................................................28

Cost of the Bailout.................................................................................................................................28

The German Decision............................................................................................................................30

References.................................................................................................................................................31

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AbstractThe Euro crisis is the impending financial crisis that the entire world is waiting and watching to

unfold. After the financial crisis that hit the global economy in 2007 which preceded by long

period of rapid crdit growth, low risk premiums, abundant availability of liquidity, strong

leveraging and development of bubbles in real estate, this crisis shows features more akin with

the Great Depression of the 1930’s. It started as a acute shortage of liquidity with the financial

institutions which was then worsened by the global meltdown. The interconnections were so

strong that EU GDP is shrunk by so much so fast, that it has never happened before in the

history.

The crisis has bought forward some very thought provoking questions regarding the policies

followed and the changes required in these areas. Some of the questions thrown around are, was

Euro a mistake? Can’t countries just get out? What is the cost of getting out? How did things get

so worse? Another interesting area of focus has been profligacy diagnosis. How much is really

too much spending? How are we supposed to cap it? When can you say “enough”?

From these questions we are now slowly moving to a place where the focus is shifting to Crisis

prevention, Crisis control and mitigation and further Crisis resolution.

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Keywords

Bailout Consequences

Euro zone

Euro crisis

Profligacy diagnosis

European Union

European Central Bank (ECB)

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European Crisis

Going back to the origin

In 1958, an organization called European Coal and Steel Community was formed. This evolved

into the European Union (EU) which was established by the Maastricht Treaty in 1993. The

European Union introduced the euro on January 1, 1999. On this day, 11 member countries of

the EU started using euro as their currency. It benefited countries such as Portugal, Italy, Ireland,

Greece and Spain (together now known as the PIIGS).

How did the Euro benefit them?

Before these countries started to use the euro as a currency, they had to borrow money at

interest rates much higher than the rates at which a country like

Germany borrowed. When these countries started to use the euro

they could borrow money at interest rates close to that of

Germany, which was economically the best managed country in

the EU.

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Another important factor is that the inflation in the PIIGS countries was higher than the

rate of interest which means that if you are borrowing at 3% interest rate but the inflation

rate is 4%, effectively the real interest rate is a negative 1%.

The setting facilitated huge borrowings on the part of these countries, not just the citizens even

the governments started to borrow which helped the politicians keep their constituency of voters

happy.

Situation in Greece

A job which paid x Euros amount in Germany, paid more than x

Euros in Greece, even though Germany is a more productive

nation. To get around the pay restraints in a calendar year Greece government simply paid

employees a 13th or 14th month salaries, month’s that didn’t even exist.

Another aberration was that Greece had classified some jobs as arduous jobs, jobs which require

more hard work. The retirement age for these jobs was 50 for women

and 55 for men. At this point in time the government has giving out

“very” generous pensions and more than 600 Greek professionals

somehow managed to get themselves classified as “arduous”, and these

professionals were people with jobs like hairdressers, musicians etc

All of this led to more and more borrowing by the government when

they already had so much debt.

Situation in Spain

Spain had the biggest housing bubble in the world. To make things clear let us quote some facts,

Spain has as many unsold homes as US even though US is 6 times bigger. Spain’s real estate

debt comes to around 50% of its GDP.

Why countries are not defaulting?

Every time a country defaults, the ECB (European Central Bank) helps out with a bailout. Since

the financial crisis ECB has bailed out $80 billion Greek, Irish and Portuguese government

bonds and lent another $450 billion to various European governments and European banks

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accepting virtually at any collateral, including Greek government bonds. Of the 126 countries

who are debt rated, Greece is now ranked 126th.

The vicious cycle

Germany contributes to the ECB rescue fund. The German government gives money to the

rescue fund so that it can give money to the Irish government so that the Irish government can

give money to the Irish banks so that the Irish banks can repay their loan to the German Banks.

Similarly a lot of German and French banks will be in trouble if Greece defaults.

The other countries - interconnection

Let’s start from Hungary. In 2004, the interest rates in Hungary(Not a Euro

using country) were at 12.5% which means that borrowing was extremely

expensive. In neighboring Austria, the banks had started to offer loans and

mortgages to their customers in Swiss francs. Rates in Austria, at 2%, may

have been lower than in Hungary, but in Switzerland, they were even lower at around 0.5%.

Austrians went for a loan at 0.5 %.Same philosophy applied to the Hungarians also, except that

the difference in interest rates was much bigger and Austrian banks in Hungary started offering

German goverment

Rescue fund

Irish government

Irish banks

Repay loans to German banks

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loans at their low interest rates. Now Austrian banks have lent 140% of their GDP to other

countries. If these countries are not able to repay, the

Austrian government wouldn’t be able to save the banks and

ECB might have to step in.

Similarly, Swedish banks have also lent a lot of money to

Estonia, Lithuania and Latvia, countries which aspire to have

Euro as their currency some day. So, they are all interconnected.

Getting out of Euro?

The reason why countries cannot simply get out of euro, print their own money and repay the

debts is that printing of money reads to devaluation of the real value of the currency. If that

happens then the citizens of the country would prefer to keep their money in assets that actually

have more value like gold or the euro itself. And in order to do that they would try to get their

money from the bank, if all the depositors line up outside the bank for their money then the bank

will collapse. That’s the problem.

Take the example of Italy, Households and firms, anticipating that domestic deposits would be

redenominated into the lira (Italy's currency before it started using the euro), which would then

lose value against the euro, would shift their deposits to other euro-area banks. A system-wide

bank run would follow. Investors anticipating that their claims on the Italian government would

be redenominated into lira would shift into claims on other euro-area governments, leading to a

bond market crisis and this would be the mother of all financial crises.

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Measures taken to prevent the crisis

Broadly classified the following are the measures taken to help Greece fill its debt crater:

Bailout Package

The first measure that was taken was a bailout package amounting to 110 billion Euros

which was put together by the Eurozone countries and the International Monetary Fund

and given as a loan to Green on 2 May 2010.

Loan was provided on conditions that there would be implementation of harsh austerity

measures.

This package was too small to fill the debt crater so other measures had to be taken.

Emergency Parachute

A parachute amounting about 7 times the bailout package was created not just for Greece

but also for other countries that were showing signs of financial weakness.

The 27 EU member states agreed to create the European Financial Stability Facility, a

legal instrument aiming at preserving financial stability in Europe by providing financial

assistance to eurozone states in difficulty. The EFSF can issue bonds or other debt

instruments on the market with the support of the German Debt Management Office to

raise the funds needed to provide loans to eurozone countries in financial troubles.

Measures taken to help Greece

Bailout package = 110 billion Euros

Parachute = 770 billion Euros

Europe's Stabilization Mechanism

European Central Bank (ECB)

Savings package Euro bonds

European CountriesECB Greek Govt.

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This money like the bailout package was a loan and was to be given only under the

condition that the governments acted more responsibly in the firm.

It is a short term measure, to last up to 2013, after which they expect the stabilization

mechanism to take effect.

European Stability Mechanism

The European Stability Mechanism (ESM) is a permanent rescue funding program to

succeed the temporary relief provided by the bailout package and the emergency

parachute. The ESM is due to be launched in mid-2013.

German Finance Minister Wolfgang Schaeuble was quoted saying paid-in capital of the

ESM may be around 80 billion Euros, giving it a total capacity of 500 billion Euros.

Again the money is a loan which needs to be paid back by the country that is taking the

loan.

European Central Bank (ECB)

ECB is lending a lot of money to Greece because private banks are very reluctant to give

money to Greece.

This is against the very principle of the ECB, but it has made an exception in this case

because the Greece debt is very huge.

Savings package by the Greek Government

This measure is devised by the Greek government, they have devised a savings package

but the citizens are protesting against this package, because they feel it’s unfair that they

should pay for the mismanagement by the government.

The Greek government also plans to privatize. They will be selling shares of some of its

state businesses.

Proposed 6th measure – Euro Bonds

On 21 November 2011, the European Commission suggested that eurobonds issued

jointly by the 17 euro nations would be an effective way to tackle the financial crisis.

Using the term "stability bonds", Jose Manuel Barroso insisted that any such plan would

have to be matched by tight fiscal surveillance and economic policy coordination as an

essential counterpart so as to avoid moral hazardand ensure sustainable public finances.

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Germany remains opposed to take over the debt and interest risk of states that have run

excessive budget deficits and borrowed excessively over the past years. The German

government sees no point in making borrowing easier for states who have the problem

that they borrow so much until they went in a debt crisis. Germany says that Eurobonds,

jointly issued and underwritten by all 17 members of the currency bloc, could

substantially raise the country's liabilities in the debt crisis.

However, a growing field of investors and economists say it would be the best way of

solving the debt crisis.

Guy Verhofstadt, leader of the liberal ALDE group in the European parliament suggested

following a proposal made by the "five wise economists" from the German Council of

Economic Experts, on the creation of a European collective redemption fund. It would

mutualise euro zone debt above 60%, combining it with a bold debt reduction scheme for

countries not on life support from the EFSF.

The introduction of euro bonds matched by tight financial and budgetary coordination

may well require changes in EU treaties, which is widely expected to be discussed at the

9 December EU summit.

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Was the Euro a good idea?

To comment on looking at the past of the European Union that whether the creation of the Euro

was good or bad, one should see why the euro was created.

When the EU was founded in 1957, the Member States concentrated on building a 'common

market' for trade. However, over time it became clear that closer economic and monetary co-

operation was needed for the internal market to develop and flourish further, and for the whole

European economy to perform better, bringing more jobs and greater prosperity for Europeans.

In 1991, the Member States approved the Treaty on European Union (the Maastricht Treaty),

deciding that Europe would have a strong and stable currency for the 21st century.

Maastricht Treaty

The Maastricht Treaty stipulates five criteria that countries must meet to become eligible for the

single European currency, the euro. These criteria must be achieved over the year before the date

of examination. As membership will be determined in early 1998, the criteria thus apply to 1997.

They are as follows:

Price Stability

To qualify, a country's inflation rate must not exceed the average inflation rate of the

three best performing Member States by more than 1-1/2 percent. (Inflation is measured

by means of the consumer price index.)

Fiscal Prudence

To qualify, a country must not exceed either of the following two reference values

relative to its gross domestic product at market prices:

1. 3 percent for the ratio of the planned or actual government deficit to GDP;

2. 60 percent for the ratio of government debt to GDP.

Successful EMS Membership

To qualify, a country must have stayed within the normal fluctuation margins provided

for by the Exchange Rate Mechanism of the European Monetary System, for at least two

years, without devaluing against the currency of any other Member State.

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Interest-Rate Convergence

To qualify, the durability of convergence must be reflected in the long-term interest rate

levels. A Member State must have had an average nominal long-term interest rate that

does not exceed by more than 2 percentage points that of, at most, the three best

performing Member States in terms of price stability. (Interest rates are measured on the

basis of long term government bonds or comparable securities.)

Some countries indicated that they did not intend to participate immediately in the Euro. These

countries are Britain, Denmark, and Sweden. The only country that did not meet the two most

important criteria, price stability and interest-rate convergence, is Greece, and thus it did not

qualify for membership in 1999. However, by June 2000, Greece has made sufficient progress so

that Greece will join the euro by January 1, 2001. The criterion on successful membership in the

exchange rate mechanism (ERM) of the EMS did not pose a serious threat for membership. In

1999, only Britain, Greece, and Sweden did not participate in the ERM.

The benefits of the euro are diverse and are felt on different scales, from individuals and

businesses to whole economies. They include:

More choice and stable prices for consumers and citizens

Greater security and more opportunities for businesses and markets

Improved economic stability and growth

More integrated financial markets

A stronger presence for the EU in the global economy

A tangible sign of a European identity

Many of these benefits are interconnected. For example, economic stability is good for a

Member State’s economy as it allows the government to plan for the future. But economic

stability also benefits businesses because it reduces uncertainty and encourages companies to

invest. This, in turn, benefits citizens who see more employment and better-quality jobs.

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How do these benefits of the euro arise?

The single currency brings new strengths and opportunities arising from the integration and scale

of the euro-area economy, making the single market more efficient.

Before the euro, the need to exchange currencies meant extra costs, risks and a lack of

transparency in cross-border transactions. With the single currency, doing business in the euro

area is more cost-effective and less risky.

Meanwhile, being able to compare prices easily encourages cross-border trade and investment of

all types, from individual consumers searching for the lowest cost product, through businesses

purchasing the best value service, to large institutional investors who can invest more efficiently

throughout the euro area without the risks of fluctuating exchange rates. Within the euro area,

there is now one large integrated market using the same currency.

Benefits worldwide

The scale of the single currency and the euro area also brings new opportunities in the global

economy. A single currency makes the euro area an attractive region for third countries to do

business, thus promoting trade and investment. Prudent economic management makes the euro

an attractive reserve currency for third countries, and gives the euro area a more powerful voice

in the global economy.

Scale and careful management also bring economic stability to the euro area, making it more

resilient to so-called external economic 'shocks', i.e. sudden economic changes that may arise

outside the euro area and disrupt national economies, such as worldwide oil price rises or

turbulence on global currency markets. The size and strength of the euro area make it better able

to absorb such external shocks without job losses and lower growth.

Realizing the benefits

The euro does not bring economic stability and growth on its own. This is achieved first through

the sound management of the euro-area economy under the rules of the Treaty and the Stability

and Growth Pact (SGP), a central element of Economic and Monetary Union (EMU).  Second, as

the key mechanism for enhancing the benefits of the single market, trade policy and political co-

operation, the euro is an integral part of the economic, social and political structures of today’s

European Union.

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So, creation of neither a good idea nor a bad idea, as it could be seen from the below pros and

cons. It was a good notion of introducing a common currency but allowing countries like Greece

to have a spendthrift government and not monitoring them at the correct time were the reason

that this good notion has turned into a bad idea.

Pros and Cons for and against the Euro while the Euro was getting created:

Arguments for a single European currencyArguments against a single European

currency

Transaction Costs

Having to deal with only one currency

will reduce the cost of converting one

currency into another. This will benefit

businesses as well as tourists.

No Exchange Rate Uncertainty

Eliminating exchange rates between

European countries eliminates the risks

of unforeseen exchange rate revaluations

or devaluations.

Transparency & Competition

The direct comparability of prices and

wages will increase competition across

Europe, leading to lower prices for

consumers and improved investment

opportunities for businesses.

Strength

The new Euro will be the among the

Cost of Introduction

Consumers and businesses will have to

convert their bills and coins into new

ones, and convert all prices and wages

into the new currency. This will involve

some costs as banks and businesses need

to update computer software for

accounting purposes, update price lists,

and so on.

Non-Synchronicity of Business Cycles

Europe may not constitute an "optimum

currency area" because the business

cycles across the various countries do

not move in synchronicity.

Fiscal Policy Spillovers

Since there will only be a Europe-wide

interest rate, individual countries that

increase their debt will raise interest

rates in all other countries. EU countries

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strongest currencies in the world, along

with the US Dollar and the Japanese

Yen. It will soon become the 2nd-most

important reserve currency after the US

Dollar.

Capital Market

The large Euro zone will integrate the

national financial markets, leading to

higher efficiency in the allocation of

capital in Europe.

No Competitive Devaluations

One country can no longer devalue its

currency against another member

country in a bid to increase the

competitiveness of its exporters.

Fiscal Discipline

With a single currency, other

governments have an interest in bringing

countries with a lack of fiscal discipline

into line.

European Identity

A European currency will strengthen

European identity.

may have to increase their intra-EU

transfer payments to help regions in

need.

No Competitive Devaluations

In a recession, a country can no longer

stimulate its economy by devaluing its

currency and increasing exports.

Central Bank Independence

Previously, the anchor of the European

Monetary System has been the

independence of the German

Bundesbank and its strong focus on price

stability. Even though the new European

Central Bank (ECB) will be nominally

independent, it will have to prove its

independence. This will at the very least

incur temporary costs as it will have to

be extra-tough on inflation.

Excessive Fiscal Discipline

When other governments exert pressure

on a government to reduce borrowing, or

even pay fines if the budget deficit

exceeds a reference value, this may have

the perverse effect of increasing an

existing economic imbalance or

deepening a recession

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Will the Euro zone disintegrate in the near future?

Many economists and political leaders are pondering on the question 'When will the Euro zone

collapse?' and not on 'Will the Euro zone collapse?'. But many

others have the view that European leaders won't let the Euro

zone to disintegrate as the break-up would be too dreadful to

contemplate. Let us first consider the costs involved in the break-

up.

Even as the euro zone hurtles towards a crash, most people are

assuming that, in the end, European leaders will do whatever it takes to save the single currency.

That is because the consequences of the euro’s destruction are so catastrophic that no sensible

policymaker could stand by and let it happen. If Euro zone disintegrate, the world’s most

financially integrated region would be ripped apart by defaults, bank failures and the imposition

of capital controls. The euro zone could shatter into different pieces, or a large block in the north

and a fragmented south. We consider two scenarios. One, Germany could leave, either on its

own or with a select group of small economies. Second, Greece might secede or be forced out.

According to UBS, if a stronger country like Germany were to leave, the cost for every German

adult and child would range from 6,000 to 8,000 Euros ($8,000 to $10,600), or about 20 to 25

percent of its annual GDP. If a weak country like Greece left the euro, the economic costs would

be severe. Leaving the euro would cost each "weak country" citizen between 9,500 to 11,500

Euros ($12,650 to $15,300), or about 40 to 50 percent of that country's GDP. And that's just in

the first year.A eurozone crash, the European commission has predicted, would see £10 trillion

wiped off the value of the European economy, a catastrophe that would send living standards

plummeting to the levels of Latin America. The shock would wipe out all the gains of Europe’s

longest period of peace since the Second World

War and herald the political chaos and collapse of

governments that ushered in Nazism 80 years ago.

Yet the threat of a disaster does not always stop it

from happening. The chances of the euro zone

being smashed apart have risen alarmingly, thanks

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to financial panic, a rapidly weakening economic outlook and pigheadedbrinkmanship. The odds

of a safe landing are dwindling fast.Investors’ growing fears of a euro break-up have fed a run

from the assets of weaker economies, a stampede that even strong actions by their governments

cannot seem to stop. The latest example is Spain. Despite a sweeping election victory on

November 20th for the People’s Party, committed to reform and austerity, the country’s

borrowing costs have surged again. The government has just had to pay a 5.1% yield on three-

month paper, more than twice as much as a month ago. Yields on ten-year bonds are above

6.5%. Italy’s new technocratic government under Mario Monti has not seen any relief either: ten-

year yields remain well above 6%. Belgian and French borrowing costs are rising. And this

week, an auction of German government Bunds flopped.The panic engulfing Europe’s banks is

no less alarming. Their access to wholesale funding markets has dried up, and the interbank

market is increasingly stressed, as banks refuse to lend to each other. Firms are pulling deposits

from peripheral countries’ banks. This backdoor run is forcing banks to sell assets and squeeze

lending; the credit crunch could be deeper than the one Europe suffered after Lehman Brothers

collapsed.

Past financial crises show that this downward spiral can be arrested only by bold policies to

regain market confidence. But Europe’s policymakers seem unable or unwilling to be bold

enough. The much-ballyhooed leveraging of the euro-zone rescue fund agreed on in October is

going nowhere. Euro-zone leaders have become adept at talking up grand long-term plans to

safeguard their currency—more intrusive fiscal supervision, new treaties to advance political

integration. But they offer almost no ideas for containing today’s conflagration.The European

Central Bank (ECB) rejects the idea of acting as a lender of last resort to embattled, but solvent,

governments. The fear of creating moral hazard, under which the offer of help eases the pressure

on debtor countries to embrace reform, is seemingly enough to stop all rescue plans in their

tracks. Yet that only reinforces investors’ nervousness about all euro-zone bonds, even

Germany’s, and makes an eventual collapse of the currency more likely.This cannot go on for

much longer. Without a dramatic change of heart by the ECB and by European leaders, the

single currency could break up within weeks. Any number of events, from the failure of a big

bank to the collapse of a government to more dud bond auctions, could cause its demise. If the

markets balk, and the ECB refuses to blink, the world’s third-biggest sovereign borrower could

be pushed into default.

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Germany’s unwillingness to share the pain and save the Euro zone illustrates the fundamental

problem of the monetary union. Historically, the success of monetary unions depended largely

on two factors: the similarity of the economies and the will to stay together. The Euro zone is

weak in these two factors. The economies of persistent trade-surplus countries like Germany are

significantly different from persistent trade-deficit countries like Greece. These countries should

not share one currency and one monetary policy. This discrepancy could conceivably be solved

if Germany subsidizes Greece forever. However, such permanent fiscal transfers are politically

impossible in the Euro zone, where Germans are Germans and Greeks are Greeks. Indeed, each

Euro zone member is its own country.

Can anything be done to avert

disaster? The answer is still yes, but

the scale of action needed is growing

even as the time to act is running

out. The only institution that can

provide immediate relief is the ECB. As the lender of last resort, it must do more to save the

banks by offering unlimited liquidity for longer duration against a broader range of collateral.

Even if the ECB rejects this logic for governments—wrongly, in our view—large-scale bond-

buying is surely now justified by the ECB’s own narrow interpretation of prudent central

banking. That is because much looser monetary policy is necessary to stave off recession and

deflation in the euro zone. If the ECB is to fulfill its mandate of price stability, it must prevent

prices falling. That means cutting short-term rates and embarking on “quantitative easing”

(buying government bonds) on a large scale. And since conditions are tightest in the peripheral

economies, the ECB will have to buy their bonds disproportionately.

Vast monetary loosening should cushion the recession and buy time. Yet reviving confidence

and luring investors back into sovereign bonds now needs more than ECB support, restructuring

Greece’s debt and reforming Italy and Spain—ambitious though all this is. It also means creating

a debt instrument that investors can believe in. And that requires a political bargain: financial

support that peripheral countries need in exchange for rule changes that Germany and others

demand.This instrument must involve some joint liability for government debts. Unlimited

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Eurobonds have been ruled out by Mrs. Merkel; they would probably fall foul of Germany’s

constitutional court. One promising idea, from Germany’s Council of Economic Experts, is to

mutualise all euro-zone debt above 60% of each country’s GDP, and to set aside a tranche of tax

revenue to pay it off over the next 25 years. Yet Germany, still fretful about turning a currency

union into a transfer union in which it forever supports the weaker members, has dismissed the

idea.This attitude has to change, or the euro will break up. Fears of moral hazard mean less now

that all peripheral-country governments are committed to austerity and reform. Debt

mutualisation can be devised to stop short of a permanent transfer union.

Hence we can say that unless Germany and the ECB move quickly, the single currency’s

collapse is looming.

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Profligacy Diagnosis

When European Union was inducting countries into its ambit, it sets out clear conditions which

were prerequisites for a country to fulfill so as to become a member of EU. These conditions also

included a cap on fiscal deficit which is not to be exceeded by 3 % of the GDP. But even

countries like Greece who were running large deficits at that time were able to enter into the

Union by fudging their account books. Even after becoming member of the EU, they did not try

to comply with the rules and keep on running large deficits. So this excessive state spending has

led to unsustainable levels of debt and deficits that have threaten economic welfare of the EU

countries. So when Greece national debt mounted up due to losses in the main industries i.e.

tourism and shipping due to economic crisis of 2008, they approached IMF to seek help but

being thrashed for running such large deficits. It was being asked to implement some harsh

austerity measures as Greece was running a fiscal deficit of 12.7 % of GDP. The below graphs

show the fiscal deficits and public debts of various member countries of European Union.

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Now profligacy in the past by these countries is considered to be one of the major reasons for

their current situation. Even the Europe’s countries which are running surpluses are right in

claiming that the euro would work if effective discipline could be imposed on others, but they

are deluding themselves from the mortality play. If we take the case of Spain and Ireland who

were running budget surpluses till 2007 became the victim of banking and property bust. Even

Italy was maintaining a big but stable public debt. So we can infer that although the symptoms of

these countries might be the same but the reasons are different so the diagnosis cannot be on the

same lines for all countries.

Moreover the diagnosis prescribed doesn’t address today’s problem which is huge debts.

The austerity measures taken by the government like increase in tax and decrease in government

spending just ensure that they will be able to manage their finances in the coming future but

paying off the previous debts is the monster hunting the Euro Nations.Any kind of austerity

measure will led to following effects on the economy:

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Political Impact In the countries like Greece where people are not ready to pay high taxes and

they will unwelcome this measure and there may be internal unrest in the country the signs of

which are visible in the current situation itself.

Economic Impact Less spending by government will stall the growth of the country. Thus it will

severely affect the unemployment rate and it can further put the country into deeper recession.

And the Europe’s leaders know this. They know that the growth is needed. But rather

than deal with today’s problem and find a solution for growth, they prefer to deliver homilies

about what some previous government should have done. This may be satisfying for the

sermonizer but it won’t solve Europe’s problems and it won’t save euro.

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Germany :Central to the solution of the Euro crisis

Germany’s History in EuropeGermany was one of the founding nations of the European Union, which was designed to ensure

that the continent would never again be torn apart by war. Following World War II, Germany's

neighbors wanted to hobble any future attempts by the nation to remilitarize; the French decided

that the best way to do this was economically, rather than ideologically.

The new Europe was built around that Franco-German relationship, starting from a clean slate.

European integration became a part of the rehabilitation of Germany as a nation among nations.

In the post-war years, West Germany enjoyed a massive boom, as the nation made the most of

the support it was offered and the opportunities that came its way to recover from the devastation

of WWII. West Germany flourished in the 1950s, 60s and 70s while other European nations,

including France and Britain, struggled.

But reunification with East Germany in 1990 following the fall of the Berlin Wall and the

collapse of the Soviet Union dented the country's fortunes. Resources had to be transferred from

rich regions to poorer ones. The government ended up overspending and had to make

fundamental economic reforms. However, they were able to reform at the right time.

Ever since, Germany has been the economic powerhouse of Europe, but the nation is not

immune to the global financial crisis. It is the continent's largest economy, but it also has a high

rate of government debt, at 83.2% of GDP, and higher unemployment -- at 7.1% -- than many of

its neighbors, according to 2010 figures. Much of Germany's might comes from its strong

manufacturing sector, which has meant that, unlike many of its neighbors, the country has not

had to rely on the financial services industry or the property market, both of which have been

badly hit by the global economic crisis.

In the present scenario, it is understandable that there is a degree of resentment on the part of

German citizens, when faced with the responsibility of clearing up another neighbor's mess. But

so was the case when West Germany rescued East Germany.

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Germany is now in a Catch-22 situation. The Americans, and others, demand that Germany takes

action, but when they do, they are accused of trying to “take over” Europe once again.

Germany’s Current Role and Actions

Germany's role in the economy of the region is extremely crucial. This has been becoming more

and more apparent as the crisis has deepened. The reason is quite simply that Germany has the

largest economy in Europe and hence, the fate of Europe depends on Germany. While the

economies of most European Union countries have been languishing since 2008, Germany's

economy has been booming since the country managed to quickly emerge from the global

financial crisis that hobbled many others. However, Germany is stalling in taking the steps

necessary to resolve the crisis. The continuation of the crisis has so far benefited rather than

damaged Germany’s economic interests. The euro/dollar rate is kept lower than it would be in

the absence of a crisis, thus helping German exports. In addition, the German government’s

borrowing rates are lowered by the flight of capital from the bonds of eurozone countries into

German bonds.

But there are recent indications that even the German economy is slowing down and, before

long, is bound to be adversely affected by the contractionary policies of its European trading

partners. GDP in the last quarter went up just 0.1 per cent. Industry sales have stagnated and

foreign demand for German products is falling.

There are numerous measures that would help end the crisis that Germany is resisting. The first

one is the creation of a European Treasury. The common treasury must be able to raise taxes

across the eurozone, coordinate and control national fiscal policies, issue bonds and perform all

the functions required of a federal state treasury, while being accountable to the European

Parliament. It is easier said than done, however, there is no doubt that this would be a truly great

step forward in the deepening of European integration and the realization of a federal state.

The second major necessary reform concerns the role of the European Central Bank (ECB). The

ECB should be responsible not only for the containment of inflation but also for the proper

functioning of the financial system across the euro zone. It must be empowered to control the

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banking system without constraints and, in exchange, operate without inhibitions as the lender of

last resort for both financial institutions and national treasuries. Either one of these two reforms

would be, in all likelihood, a sufficient response to the crisis. The two reforms constitute jointly

the first-best solution to Europe’s financial problems. If they were adopted, not only could the

present crisis immediately come to an end, but it might also serve as a decisive step towards a

federal Europe.

This would be in the best tradition of European integration, which has tended to proceed by

resolving problems caused from incomplete though politically feasible previous measures. But

politicians, with their eyes firmly fixed on their electoral chances and on political alliances

necessary to governmental coalitions, are not currently ready for such major advances.

Opposition to the creation of a European Treasury is, of course, understandable among euro-

skeptical political parties. Any move towards a common treasury clearly implies a reduction of

national sovereignty, as national fiscal policy will need approval and may be subject to a possible

veto by institutions at the European level. Ironically, the present crisis serves as a caution against

possible, unseen, ill-effects of such a step in the future.

Moreover, a common treasury would have to take a view of the economic situation and needs

throughout Europe and redistribute resources, most likely from the strongest to the weakest

countries and regions. Thus, it is not surprising that political leaders in Germany and other

economically strong countries would be opposed to this reform.

There is also German opposition to expanding the power and responsibilities of the ECB. This is

based on the fear that, by allowing the ECB to directly lend to governments, the euro will be

debased and hyperinflation will follow.

But central banks all over the world lend to their governments without causing hyperinflation.

The remote possibility of huge mismanagement sometime in the future does not justify taking

today the extreme risk of a financial meltdown that can easily be averted by an adequately

empowered central bank.

It is now imperative that national prejudices are set aside and Germany reasserts the primacy of

the European project by leading the way towards a federal Europe. This means that two things

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should be done immediately: First, empowerment of the ECB to lend to solvent states, so as to

calm the waters and restore confidence in financial markets.

Second, immediate announcement of a summit to prepare a new European Treaty establishing a

common treasury and making a major advance in the construction of a federal European state.

Cost of Breaking UpA breakup of the euro zone would have grim, long-lasting social and political consequences that

extend far beyond its economic costs — an ugly risk that is widely underestimated, according to

UBS AG, a Swiss bank.

The economic costs of breaking up the euro are high, and extremely damaging. The political

costs of breaking up the euro, even in part, are too great to quantify in bald cash terms.

Following a breakup, euro countries would barely have a whisper on the world stage. It has been

seen how past instances of monetary union breakups tend to spark either an authoritarian

response from the government or create social disorder and civil war.

Sovereign default, corporate default, collapse of the banking system and international trade are

just some of the problems a seceding peripheral euro-zone country would have to face. That

could entail an initial cost of around 9,500-11,500 euros per person in that country followed by

an annual cost of 3,000-4,000 euros per person. Even if a stronger country like Germany were to

leave, UBS still thinks it is going to set every German back by about 6,000-8,000 euros in the

first year and then around 3,500-4,500 euros per person in every year thereafter. A stronger euro-

zone country wouldn’t face sovereign default but it is still vulnerable to corporate default,

recapitalization of the banking system and a collapse of international trade.

By contrast, each German would only have to cough up 1,000 euros just once to bail out Greece,

Ireland and Portugal entirely, according to UBS’s analysis. However, this argument alone is not

justification enough for the Germans.

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Cost of the BailoutOf the 126 countries with a Standard & Poor's rated debt, Greece ranks 126th, winning the award

of the country perceived as the least likely to repay its debt. Greece is not alone in its misery in

the E.U. There’s Portugal and its junk-like debt; Italy and France, which may soon follow the

United States into the ignominy of downgraded credit ratings; and Spain, which just

acknowledged its debt is deeper than it thought.

The only major European economy left standing is Germany. Some of the continent's smaller

countries, like Finland, are doing well, but Germany stands head and shoulders above its E.U.

partners in its ability to bail out deadbeat neighbors. With an unemployment rate of 6.4 percent

(France stands at 9.5 percent) and relatively high private saving rates compared to other

countries (12.1 percent), Germany has been growing at a 2.6 percent rate when everyone is

suffering from anemic growth.

However, political concerns also factor in. Chancellor Angela Merkel finds herself in a tough

spot. Her popularity is at its lowest point since 2006; her party was just trounced in recent local

elections. Germany bailed out fiscally irresponsible countries for fear that a Greek or Irish

default would trigger a bank run in other weak countries like Portugal and Spain. A continent-

wide bank run, the Germans reasoned, might destroy Europe's banking system. But Germans are

increasingly unhappy and morally outraged with the situation. They've already bailed out Ireland,

Greece and Portugal. Now they are being told that more money is needed. In addition, they

understand that if Greece defaults on its debt, the European Central Bank might face insolvency

along with other E.U. countries. All those beggared institutions would then turn for funds to its

one solvent member government: Germany. That means yet more bailouts. Germans are

especially losing patience over the continued demonstrations in Greece over the government’s

austerity measures which they see as signs that the Greeks are uninterested in changing the

behaviors that got them into trouble in the first place.

But so far, German outrage is mainly moral. That can change quickly. They spent years of

paying extra taxes toward the successful German reunification (without any help from other

countries). They've bailed out profligate countries. Now they are being asked for still more.

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The bailouts so far haven't cost Germans a euro since the real costs are mostly in the future. But

once Germans internalize all the costs they have already paid or may be on the hook for, their

attitude may change quickly. As new bailouts are requested, as countries fail to reform their

bloated welfare states, no one can be surprised if the Germans start seriously questioning their

attachment to European solidarity. Why should they work two or three extra years to pay for

their neighbors' early retirement policies? And nobody can deny the logic behind that question.

However, it is a tricky situation due to the high future cost to itself of denying its neighbors any

more help. On the other hand is the option that lets its feckless, profligate neighbors easily off

the hook and might let them get away without reform or rectitude (or at least that is how the

Germans would see it for now).

One can draw a parallel to the biblical proverb - spare the rod, spoil the child! Of course not! The

other option is - pick up the rod and thrash the child! Harsher still?

The German DecisionGermany, without asking for it, now plays a central role in effecting the outcome of the Euro

Crisis. There are going to be massive costs for the country one way or the other. Be it from the

disorderly breakup of the euro zone and a move to the old currency or the cost of a bailout for the

struggling neighbors. The decision is a difficult one. It has to be made keeping long term

interests in mind, both for the country itself as well as for the EU, which would, sooner or later,

have consequences for Germany. And then some for the rest of the world.

Page 32: European Crisis Final1

References

http://www.rediff.com/business/slide-show/slide-show-1-all-about-european-debt-crisis-in-

simple-terms/20110819.htm

http://en.wikipedia.org/wiki/European_sovereign_debt_crisis

http://en.wikipedia.org/wiki/Eurozone

http://www.ibtimes.com/articles/248284/20111112/eurozone-collapse-2011-endgame-

begins.htm

http://www.telegraph.co.uk/finance/financialcrisis/8882812/Eurozone-collapse-will-send-

continent-into-depression.html

http://www.economist.com/node/21540255

http://www.ft.com/intl/cms/s/0/5030759e-49bd-11e0-acf0-00144feab49a.html#axzz1gGlqRgrK


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