The European Debt Crisis: A Continental Virus

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The European Debt Crisis: A Continental Virus
Hamill, Robert
Stephens, Michael
Kanai, Devin
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Subjects / Keywords:
Banking crises ( jstor )
Countries ( jstor )
Currency ( jstor )
Debt ( jstor )
Economics ( jstor )
Financial bailouts ( jstor )
Financial bonds ( jstor )
Gross domestic product ( jstor )
Investors ( jstor )
Monetary policy ( jstor )
Debts, Public
European Union
Undergraduate Honors Thesis


The European Debt Crisis is a global economic battle being fought by corporations, governments, and families. In this paper, we will explore this crisis by investigating the contagion factor and how the crisis was able to spread across so many countries in a relatively short time. The contagion factor will comprise the effects of globalization and how increasing interconnectedness amplifies the effects of a debt crisis while simultaneously decreasing the lag time between countries. We will show how this interconnectedness is driven by the unified Euro, financial markets and institutions, and a “one size fits all” policy of the European Union. We will then explore the global ramifications that have resulted due to the debt crisis. The ramifications we discuss will be focused on: hardest hit nations, financial markets, corporations, and the household. Lastly, we will delve into the responses taken to fight the crisis and how the battle is an ongoing struggle. Specifically, we will examine: a brief synopsis, monetary policy, financial regulation, how the crisis is still being fought, an outline and timeline for a possible cure. The purpose of our analysis was to analyze the feasibility of the European Union as a sustainable long-term economic strategy for those countries that that comprise it. We believe that the debt crisis is an economic anomaly that would have led European society worse off as a whole if the EU had not existed. So the EU is a viable long term economic structure provided that some changes are made to hedge against future economic crisis risks. ( en )
General Note:
Robert Hamill awarded Bachelor of Science in Business Administration; Graduated May 8, 2012 cum laude. Major: Finance
General Note:
College/School: Warrington College of Business Administration
General Note:
Advisor: Dr. John Banko

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University of Florida
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University of Florida
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Group 9: Rob Hamill, Michael Stephens, and Devin Kanai The European Debt Crisis: A Continental Virus The European Debt Crisi s is a global economic battle being fought by corporations, governments, and families. In this paper, we will explore this crisis by investigating the contagion factor and how the crisis was able to spread across so many countries in a relatively short time. The contagion facto r will comprise the effects of globalization and how increasing interconnectedness amplifies the effects of a debt crisis while simultaneously decreasing the lag time between countries. We will show how this interconnectedness is driven by the unified Euro We will then explore the global ramifications that h ave resulted due to the debt crisis. The ramifications we discuss will be focused on: hardest hit nations, fin ancial markets, corporations, and the household. Lastly, we will delve into the responses taken to fight the crisis and how the battle is an ongoing struggle. Specifically, we will examine: a brief synopsis, monetary policy, financial regulation, how the crisis is still being fou ght, an outline and timeline for a possible cure. The purpose of our analysis was to analyze the feasibility of the European Union as a sustainable long term economic strategy for those countries that that comprise it. We believe t hat the debt crisis is an economic anomaly that would have led European society worse off as a whole if the EU had not existed. So the EU is a viable long term economic structure provided that some changes are made to hedge against future economic crisis r isks.


The Outbreak national accounts. Greece was effectively hiding its debt from the rest of the world, and when this information was released fear swept across the Eurozone; which is an economic and monetary union of 17 European countries. This led to a large increase in the credit spread of 1000 bp s (10%) premium over German bonds (Bloomberg Screen) funding costs for government operations as their debt became more risky in comparison to alternate European countries This political revelation indicated that Greece was running a budget deficit of 13.6% and had a national debt level at 115% of GDP (Acropolis Now). This created a dangerous situation for Greece and the Eurozone. Greece could not economically grow out of this e xtraordinary debt because of weak exp orts Additionally, they could not inflate their debt away since they use the unified Euro. Since the n of cutting spending. However, the people of Greece were not willing to forgo their large governmentally subsidized expenditures so a political upheaval ensued. Running out of options, Greece turned to Germany and the IMF for aid. Greece once again ran into a roadblock, because the taxpayers of Germany were not willing to sup port the irresponsible spending of Greece. Further fear fabricated that the credit issuing countries and institutions would not receive full repayment of principal and Greece wou ld default; leading to credit spreads and funding costs throughout the Eurozon e. bailout. So, a combined effort by the European Union and the IMF issued a package (Acropolis Now)


Ireland has acted as another key player in the European Debt Crisis. Their economic boom turned into a large housing bubble in response to low interest rates a ccompan ies by mindless spending and low financial regulation. This bubble led to inflated land prices and a massive increase in the construction industry; supply of housing outstretched demand by 400% from 2006 2009 (After the Race). This massive bubble popped when the effects of the default of Lehman Brothers hit Ireland creating a bankruptcy scenario for several large financial institutions. The stitutions. billion bailout package from the EU and IMF (After the Race). Even though Greece and Ireland experienced the largest outbreaks several other countries exhibited their own signs of infection. Spain and Portugal also became distressed during this debt crisis Spain also had a housing bubble and bust that led to the destruction of their construction industry. This has led to Spain having an unoccupied housing surplus of roughly 1 million homes. For a frame of reference, this is three times as many unoccupied houses on a per capita basis as the U.S. (Seltzer). With this large oversupply o f housing, there is no demand for new home building and thus no demand for laborer s in the construction industry. The economic multiplier effects of this bust has led Spain to an 18% unemployment rate which has increased production costs and lowered export s creating an e conomic standstill (One Size). This fall in the housing and construction industry is not contained in just Spain. In April 2010, the STOXX European Housing and Construction Index had fallen 17.3% over the first quarter of 2010 (Beaupuy) due to decreased demand and sales. During this time of economic disdain,


Portugal is experiencing financial troubles as well. Their national debt level is at 83% of GDP, they have a 9.3% budget deficit, and the public sector is expected to soon have 5% pay cuts (Portugal Under Siege ). So, as we can see these financial outbreaks are not isolated to a single area. Rather, there are different degrees of outbreaks scattered across Europe. As the infection spreads and fears heighten, there is an increased chan ce of further contamination. The Infection Spreads : Fear of Epidemic So what factors were in place to allow the economic conditions of a few countries to produce a debt crisis across an entire continent? The answer to how this infection spread lies in th e ex ploration of the infectious catalyst we will refer to as the contagion factor. This factor has been cultured from a series of conditions that have created the incubator necessary for the infection of its Eurozone host. To paint a picture of this incuba tor, we will discuss how globalization, financial markets, the Euro, and European Union monetary policy converge and intertwine the nations of the Eurozone to form a single host for our contagion to move freely through. Since the formation of the Eurozone and the implementation of the Euro, many countries throughout Europe have become unified by a common monetary policy and currency. This leads by the Economic Monetary Union that may work well for one nation, but not for others. For example, since the creation of the EMU, Greece, Ireland, Spain, and Portugal have all experienced non sustainable booms due t o this new interconnectedness. These nations cannot produce goods and serv i ces cheap enough to compete with exports or with imports from abroad (One Size). For example Spain has run


an average quarterly budget deficit of $17.4 million (OECD Database). This artificial boom was due to the European housing bubble in which wealth artificially increased while economic production decreased. This led to unsustainable rises in wages that were not supported with economic growth; as a result, inflation occurred. These international EU factors coupled with t he formation of t he EU has allowed for ease of trade with monetary policy and a common currency which benefits top Eurozone producers but hurts less efficient nations. For example, Germany, considered the strongest member of the EU, ran an average quarterly trade surplus o f $46.8 million and experienced export growth rate of 10.4% between 2009 and 2010 (OECD Database). However, since the EU is under a unified currency and monetary policy, other nations are still affected. T ax revenues go towards bailouts of these economically damaged countries. If one country is not backed during default, the contagion factor will spread to other countries as the borrowing rate increases due to increased risk created by the defaulted countr y. The unified problems. For example, countries cannot merely allow their cu rrency to inflate then repay their outstanding debts with cheaper Euros. This acti on is prevented by the European Union because the inflation of the currency could spread throughout the Eurozone and weaken other economies (Acropolis Now) So as we can see, in an attempt to strengthen the Eurozone, some countries have fallen into harsh e conomic times that will require a great deal of innovation and hard work to resolve. We will now examine the role of financial markets and financial institutions in catalyzing the contagion. There is a high degree of interconnectedness in the financial ma rkets across Europe. This can be illustrated through statistics based on the money and capital markets in the


Eurozone. The correlation between the average unsecured loan spreads in a given country and across all countries in the Eurozone has fluctuated around one since 1999 (Freixas and Hartmann 170). Additionally, news in a given country has yield change effects on both domestic and foreign bond markets. Since 2000, approximately 95% of yield fluctuations in a benchmark bond measurement can be explained t hrough news in other countries (Freixas and Hart mann 178) This illustrates that the financial markets within a given country must charge similar lending rates as other countries in order for their loans to be competitive. Any fluctuation in rates will be taken advantage of by arbitragers and borrowers to finance their investing activities If the capital and debt markets were not so interconnected, then arbitragers could take adva ntage of the discrepancies in markets in order to obtain riskless profits. An arbitrager could discover a mispricing in a given security, say a bond, trading for minute differences in the London and German exchanges. Assuming no transaction costs, the arbi trager could take a short position in the relatively overpriced security in expectations that the price will fall in the future. As more arbitragers make this bet, the equilibrium price will be reached and the arbitrager will realize a riskless profit of t he difference in prices between the two securities. Over the long term, these arbitrage opportunities will keep the markets efficient on a global scale. If this were not the case, then there would be an infinite stream of riskless profits to be made; which is obviously not feasible. Additionally, after the creation of the EU, transaction costs across Europe have been greatly reduced as capital flows have become more freely flowing. For instance, a Greek based company may develop a subsidiary in France finan ced with funds from Germany. The unification of the Eurozone has led to highly correlated financial markets in which lenders compete for the business of domestic and foreign borrowers. To illustrate how this con tributes to the contagion, we will rev isit ou r lending example. If we assume that Greek based company that


established a subsidiary in France financed with German funds goes bankrupt. In this event, the firm will not be able to pay back its funds from Germany, which results in a loss of interest reve nue and thus supply of money in Germany. Then, the firm must terminate the employment of its French workers which results in increased unemployment in France. The Greek home firm then has decreased revenue that can no longer support its expenses so the f irm goes bankrupt and increased unemployment in Greece. This then increases future financing costs to Greece making them less competitive. As we can see through this simple example, countries can invest in other members of the Eurozone with funds borrowed from yet other members in order to take advantage of the cheapest costs. However, in the event of a bad state of the world, ripples of hardship in one country are set across many countries which illustrate the effect of the contagion and its ease of sprea d across the Eurozone that contributes to the scale and scope of the European Debt Crisis. Symptoms Experienced Now that the source of the contagion factor has been described, it is time to dive into the recent economic ramifications experienced by Greece and other members of the Eurozone. Due to the unifying efforts of globalization and from being under an identical monetary policy, the coverage of the sym ptoms that nations suffered from due to the European debt crisis, a lot of effort will be focused on the nations that were impacted the most by the ordeal: Greece, Ireland, Spain, and Portugal. However, due to the global economic interconnectedness that wa s described earlier, the fallout was not simply felt by just these countries, but also by nations around the world. With fears of European nations defaulting on their loans, the strength of the euro


plummeted, and had a severe impact on the currencies of b oth industrialized and emerging market economies. In addition to the substantial weakening of the euro, the aforementioned European countries that were impacted the most by the debt crisis were issuing high risk bonds, a fact that signified a lot of invest fear was being reflected in the marketplace was exhibited through the decrease in consumer demand due to the uncertain condition of key market determinants. With a decrease in demand for their particular product, a lot of businesses had to cut costs, which contrib uted to the unemployment rate, and thus resulted in an overall decrease in consumer spending, and led to some countries needing a bailout. linked back to the 2001 Eurozone decision to admit a highly leveraged Greece into their union. In fact, when admitted, Greece had a public debt total that was over 100% of its GDP (The Econom ist). Instead of fulfilling its duty to maintain a budgetary balance in line with its revenue Economist). Due to a large amount of fear in the marketplace that Gre ece was going to be strongest member of the Eurozone, approached 4% in 2010 according to The Economist article. The fact that this large yield spread is between t wo nations with the same currency symbolizes a BBB+, which is the minimum rating that is considered to be investment grade, the country had to issue bonds with a reported 6.2% interest rate to attract potential buyers


(The Economist). Despite this incentive, yields were still rising, which meant tha t consumers were willing to pay less for a Greek bond due to the increasing fear of default. its rating of Greek bonds into its junk Associated Press The Washington Times). With many investment institutions carrying guidelines that they can only put money in investment grade opport unities, this rate slashing had yet another negative impact on the debt crisis in Greece. In tune with the initial junk bond declaration given by a package sh ared by the European Union and the International Monetary Fund ( Associated Press The Washington Times). Under the conditions of this bailout, Greek Prime Minister George Papandreou had to agree to put forth a strict financial budget that would cut the defi cit from its 2009 level of 13.6% of GDP ( Associated Press The Washington Times). In order to meet a goal of cutting the deficit to a level of 2.6% of GDP by 2014 ( Associated Press The Washington Times), Greece has plans to both cut the budget, with key con tributors such as the pension system that allowed retirees to have up to 96% of their pre retirement salary being under With the situation in Greece creating a lot of uncertainty in the international debt market, the flaws of other members of the Eurozone that had unfavorable capital structures were being exposed. In fact, the Greek debt situation helped highlight what appeared to be a dividing line amongst the Eurozone nations. According to The Economist article, there appears to be a north south divide that shows a geographic trend on the continent for financial troubles. It states that


s on exports to power its growth, saves hard and runs consumer spending, have weak public finances and rely on foreign capital to supplement their conomist). With Germany being the standard which the troubled economies such as Greece, Spain, Portugal, and Ireland are being compared to, this statement seems to be valid. With such a great division in economic policy being evident in Europe, it brings f orth the question of why the stronger northern members of the Eurozone are staying with the euro when the southern members are simply spending substantially more than their economies can support, With the great amount of inter connectedness between euro carrying nations, it is to be expected that the financial crisis in Greece was going to spread to other European countries. In Spain, a massive failure in the real estate market has yielded an unemployment rate o f 20% (Associated Press CBS News) .The article goes on to say that because the bill only and that there is likely to be a great amount of resistance to any budget cuts that are Despite the alarming 20% unemployment rate, Albert Marcet argues in his article not be a prevailing sense of fear that Spain will default on its debt. The main source of data that Marcet uses to reinforce this belief is the fact that Spain has recently committed its policy al gains taxes


which increases the amount of people in the labor force, and thus might promote a greater possibility for more unemployed people than a nation that has a lower retirement age and thus a smaller potential work force that is outlook might be starting to turn around due to its commitment toward austerity, the fact remains that a substantial amount of people are still looking for work, and in a time when there is a great amount of uncertainty amongst the members of the Eurozone, businesses will have a difficult time reaching a growth rate that would allow it to hire more people. In Ireland, a situation that is perhaps of a similar magnitude as the one Greece was experienc ing Faiola ). Despite being in great need of legislation that enacts budget cuts, the Irish government was not able to implement the necessary savings plan Faiola ). Due to these terrible economic conditions, Ireland had to choose between increasing an already vast budget deficit and letting its banking sector fail. Ireland chose to save the latter, and will thus likely suffer severe economic consequences to its employment sector in order to fund the repayment of the borrowed funds. Joe Brennan and Dara Doyle goes into just how much the Irish banking bailout will cost. After Euros Euros r that before sustainable economic


growth can be had, the Irish citizens are going to need to see proof that the banking industry is reformed and that a similar economic catastrophe will not claim the focus of their taxes in the near future (Brennan and Do yle). One way that this can be measured is to analyze the difference between Irish bonds and a more stable economy such as Germany. According to the previously year Irish bonds and German bunds of similar quite a bit of work to do in order to increase the overall confide nce in the strength of the Irish economy relative to more stable nations. Another economy that is in serious financia l trouble is Portugal, which was projected by its own Finance Ministry to have a public debt that is equal to 86.6 % of its GDP in 2011 ( Li ma ). year bonds over German bunds soared to a euro era European economies into perspective. In order to combat the deficit Portugal will cut wages by 5% for public sector workers that earn more than 1,500 Euros The cutting of wages for public sector jobs is particularly consequential because not only will it decrease the amount of goods that public employees can spend, but it also detracts more probably will Despite it being rather clear that Portugal needs to introduce quick and strict austerity Barry Hatt on reports that there is a strong resistance group forming against the latest cost cutting


ideas. The political instability will also result in increased fear that Portugal will not be able to pass the necessary austerity measures needed in order to avoid the need for a bailout. A large and eventually threaten the stability of much larger debt heavy nations such as Spain, Belgium on to state that Portugal has averaged less than a 1 percent annual growth rate in the last decade (Hatton). If Portugal is not able to settle this political unrest and commit itself toward policies that promote austerity, then it is doubtful that the eco nomy will be able to break this trend, and that it might instead need a bailout. With these four nations experiencing similar economic ramifications due to large budget deficits, the Eurozone has lost a great amount of stability relative to other markets. The fact that investors and rating agencies alike fear that these nations will default on their debt have resulted in bonds that have extremely high yield spreads relative to more stable economies, such as purchase their bonds, these nations had to put capital structure is not made before the maturity of these high yield bonds are due, then these countries will be in an even worse situation than before because they owe bonds with interest rates that are in excess of 4% more than the ones that Germany is paying to its investors. This type of debt structure is not sustainable over time. These countries that have alrea dy been bailed out, or are on the verge of potentially requesting one, need to accept policies that promote austerity so that conditions for long run growth can be had. If these countries do not cut costs, then a bailout cycle will then ensue until finally a point is reached where the governments would be simply allowed to fail. While this thought might seem like unlikely, it is certainly a


potential consequence of the financial crisis if members of the Eurozone are not more careful with their spending habits. In addition to decreasing the yield that they pay on bonds, it is in these countries best interest to change their capital structure to ones with less debt because the credit lines amongst institutions will dry up otherwise. If a massive default i s feared to be imminent, banks will not lend money to investors because of the fear that they will not be paid back. If businesses are not given loans then they will be forced to cut costs, which will thu s drive up the unemployment rate and additionally d iminish the amount of money that consumers are willing to spend This then becomes a viscous cycle until a policy like a government stimulus allows a company to hire more people. When an unemployment rate is high, such as the 20% mark that Spain is at, it is extremely difficult for there to be any sort of economic growth due to there being such little money that can be spent on non essent ial goods. The possibility of this viscous cycle occurring in these countries where the government keeps on borrowing mo ney to try to create growth and employment in the economy, which in turn makes their bonds more likely to default and thus makes the possibility of a dried up credit market more likely should be a very real concern for these economies. In order for these c ountries to have sustainable economies, austerity is a type of policy that politicians should really try to use in order to cut back on costs that are not really necessary. Prognosis and Treatment In response to the European debt crisis as a whole, the wealthier Euro Zone nations, most notably Germany and to a lesser degree France, have stepped up to bailout the distressed


countries in coordination with the European Union and the International Monet ary Fund. On May 9 th 2010, the 16 nation Euro billion in immediate loans at five percent interest with the rest to be released later. Five percent interest is considered by many to be a very high interest rate for a bailout loan, but Greece was in no position to negotiate a better deal at the time. Additionally, prior to agreeing to any monetary assi stance, Greece had to impose tough austerity measures, in addition to several rounds of their own voluntary measures, yielding billions of Euros of savings as a pre condition. The cuts were mostly targeted at public sector wages and entitlement programs, but also included tax increases on the wealthy and increases in luxury taxes on alcohol and cigarettes. Another term of the deal was that Greek Government had to sell stakes in state This hard bargaining angered many Greek citizens, who held a massive general strike to protest the austerity measures. To help address the spreading debt crisis, The European Union in tandem with the European Financial Stability Facility. This rescue fund would be available to any Euro Zone and the remaining was set up as a special purpose vehicle which will raise money by issuing bonds in the private market once a monetary request had been made. I n order to ensure demand, the European nations and the International Monetary Fund agreed to guarantee the debt.


Going forward, Germany is trying to require countries receiving bailout money to accept fiscal rules more similar their own: decrease entitle ments and increase retirement ages. Additionally, Germany and France would like to impose limits on debt into the laws of the Euro Zone countries, which is unpopular among many other countries. In addition to Greece, many countries have opted for, or be en forced to accept, austerity measures to bring their respective budgets into line with what they can actually sustain. Governments have tough choices to make, on the one hand cuts in domestic spending can help close budget deficits, but on the other han d, it can also negatively impact economic growth healthier economies, but the process will take years, economists and analysts say. In the meantime, the drag on growth is increasing pressure on the euro, and tethering competitive weakest members Zone countries dealing with heavy debt burdens and toug h austerity measures have seen little to no economic growth, unlike the United States which has a nascent recovery underway after opting for a stimulus approach. Greece was the first country to impose austerity measures, and even after several rounds of a usterity measures and a multi Finance Minister suggested that Greece re structure its debt so it can become solvent again and return to the capital markets, suggesting that Germany does not ha ve the appetite for another


and would face substantial write downs. Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co. in London, said in Tony C Germany Floats Greek Restructuring as Papandreou Seeks Cuts think, is the Ge restructuring; instead they want to institute even more austerity measures. Greek Prime Minister The measures should Ireland was the second Euro Zone country to seek a bailout. A real estate bubble and a banking crisis requiring a total of six bank bailouts costing Irish taxp eroded tax revenues and sent spending skyrocketing. As a result of the economic turmoil, Irish debt was downgraded by the major credit rating agencies, sending their borrowing costs much higher. According to the Telegraph, on November 11 th 10 year Irish government bond and its German equivalent reached its highest point since the euro was created, to 6.65 percentage points. The higher the yield on government debt, the greater the expectat debt, Ireland was forced to seek a bailout from the IMF and the EU. On November 28 th 2010 the bailout, Ireland agreed to slash billions from its budget and pay 5.8% interest, higher than the 5.2% charged to Greece. Portugal, which had a 9.3% budget deficit at the beginning of the European Debt Crisis, has put forth four separate sets of auster of a much scaled back 2011 budget on November 26 th 2010 in an effort to avoid a bailout similar


from th e EU and the IMF. Any bailout from the IMF comes with strings attached, mainly a loss down in the Parliament, which caused Prime Minister Jose Socrates to r esign on March 23 rd 2011. Prime Minister Socrates eventually came back to power, and on April 6, 2011 asked for a bailout from the IMF and the EU emergency fund. According to Bloomberg Businessweek, on. In return for a bailout, the IMF and the EU insisted that Portugal instate even deeper austerity measures. However, on April 18 th 2011 the possible bailout became uncertain as elections in Finland created a shift in power within the Finnish government towards an anti Euro political party, that created the possibility that Finland would veto the bailout. News of the potential veto pushed interest rates higher and the Euro lower as investors were unsure if the EU could properly handle the crisis. In addition to Greece, Ireland, and Portugal, several other Euro Zone countries have become saddled with huge debt and have had to pursue austerity measures. Spain was the largest economy to face serious debt trouble. It had a real estate bubble followed by a banking crisis similar to Ireland, but also had to deal with near 20% unemployment. On May 27 th 2010, Spain downgraded their debt. In December 2010 Spain underto ok further measures to restore investor confidence, selling stakes in state taxes for small businesses. The United Kingdom has also taken dramatic action against its debt problems. In fiscal year into office on the platform of fiscal responsibility, and he has been aggressive in instituting the


largest spending cuts since World War II. The cuts have been controve rsial, with student protests, high unemployment, and poor economic performance all in the name of fiscal health. However, he has delivered on fiscal health as the UK has achieved an AAA rating, lowering its borrowing cost. The economic recovery in the United States has been affected as a result of the European Debt Crisis. The US has seen less demand for exports from Europe as their purchasing power has diminished because of austerity measures and at times an unfavorable exchange rate as the Euro has will view US debt as safe comparatively. Conclusion I n this paper we have discussed how the European Debt C r isis is like an infection as it spreads across nations through the contagion factor Then, we explored the symptoms countries in the Eurozone experienced as a result of this contagious debt. Lastly, we delved into the prognosis and future treatment that policy maker s will strive to achieve in the future in order to treat this illness and prevent, or at least mitigate, future outbreaks. Our thesis was to analyze the European Debt Crisis, and from this analysis, we wanted to examine whether or not the European Union would be a successful long term economic structure given the severity of th e economic crisis. We will reexamine some of the themes discussed in the paper in the form of pros vs. cons


First, the pros will be mentioned. The EU was able to create a unified monetary policy and unite through the euro as the single currency. This allo wed for reduced transaction costs by eliminating foreign exchange costs and risks. The unified currency also provided for swift and more fluid transactions between producers and consumers across countries. These reduced costs and lag times can be used to t ransfer utility to ultimate consumers through cheaper prices of goods. The unified strength of the EU and IMF enabled troubled countries such as Greece and Ireland to receive substantial financial aid that was used to shield them from being completely erod ed through the debt crisis. The provided utility to those countries that were hardest hit by the crisis. The stronger countries in the EU such as Germany were also able to benefit from the unified currency and monetary policy through increased exports. The se large economies were able to benefit from economies of scale that were developed with freely moving capital and labor throughout the EU. The increased exports lead to increased demand, increased production, and increase in labor demand, and a sustainabl e increase in economic growth and stability. Now we will consider the cons. Most importantly, the unification of monetary policies created a substantial moral hazard problem in which countries had no incentive to control and reduce their fiscal spending po licies since they were implicitly backed by the EU and IMF. For example, the people of Greece receive large government subsidies and the average retirement age is 55. This led to massive debt levels that are currently over 115% of GDP which led to them rec eiving a bailout to prevent them from defaulting on their debt issuances. In contrast, German people are considered to be a very hardworking an d financially responsible society on average (as reflected by their economic strength in the EU), and they had to implicit guarantee. This did not sit well with the German people because the Greeks had no incentive to reduce their lavish fiscal spending; they could just receive a wealth transfer from


other stronger countries should they face default. However, the smaller countries such as Greece and Portugal were also hurt by the formation of the EU through reduced exports. Since the economic powerhouses such as Germany were able to more efficiently take advantage of economies of scale, their effective export prices were able to be lower than other smaller countries. This reduced competitive pricing reduced exports, production, and jobs in the smaller less economically developed countries. It is important to consider the context of the Europea n Debt crisis before merely weighing the pros and cons on an absolute basis. There were several pros and cons for each country size in the EU that seemed to be c losely intertwined and thus difficult to determine causal relationships and absolute advantages One factor that needs to be accounted for in the decision model of whether not the EU is a viable economic entity is the general state of the world. The European Debt Crisis started with a large housing bubble in which wealth rose artificially without th e production and wage increases to support that wealth increase. When this bubble popped, that levered wealth led to amplified losses against homeowners and investors. This created a highly distressed economic situation that any financial structure would b e crippled by. So we cannot merely dismiss the inherit value of the EU based on the general state of the world. Rather, we should examine the r eal GDP growth for the EU before 1999 between 1999 2007, and 2007 2010 We assumed the full benefits and effects of interconnectedness of the EU were not reached until the implementation of the euro in 1999. This will allow us to analyze an inflation adjusted growth in EU income before the full power of the EU, during the full power of the EU, and during a distresse d global condition. Data from the International Monetary Fund shows that the average read GDP growth from 1992 1999 (before the full power of the EU ), was at an average annual rate of 1.86%. T hen, from 1999 2007, the average annual real GDP growth for the EU


was 2.32%. This may seem trivial on an absolute basis, but this is a percentage increase of 25%. Then, from 2007 2010, average annual real GDP growth was 1.9%. So as we can see, in normal states of the world, the EU improves income for the countries in the EU on average, but reduces it in the anomaly bad states such as the one created by the global housing bubbles. Since these states of the world are rare, we believe that the EU is a viable economic structure for Europe provided that some changes are ma de to reduce some of the previously discussed cons and risks. Specifically, the moral hazard problem must be addressed so that countries in the EU are responsible for their exorbitant spending habits and so that other countries do not have to sacrifice of One solution would be to work closely with the country in maintaining their budget and capital inflows. Then, should they deviate from their fiscal policy standards by more than a predetermined amount for a predetermined number of periods, then that be reinstated to the country under certain constraints. Also, the problem of export competition and reduction needs to be examined. I f a country cannot produce at competitive prices, then their exports will not sell and they will not be able to sustain economic growth. One possible solution to this problem would be to change the comparative advantage in production throughout the EU in w hich each country or group of countries specializes within a given range of production and logistics processes. The will allow those countries to synergize to maintain competitive global prices while still lowering costs further to pass excess utility onto consumers. The EU is a very powerful economic tool that could be used to accomplish great economic feats if it is used properly and contains implicit hedges to accommodate for scenarios such as the European Debt Crisis.


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