Investment Contrarians

European Debt Crisis Explained

The European debt crisis refers to Europe’s inability to pay the debts it built up in recent decades. The European debt crisis grew out of the U.S. financial crisis of 2008-2009. A slowing global economy exposed the unsustainable financial policies of certain eurozone countries.

The eurozone is made up of 17 European countries that use the euro, including France, Germany, Spain, and Ireland. Several countries in the eurozone have borrowed and spent too much since the global recession began, causing them to lose control of their finances.

The European debt crisis can be traced back to October 2009, when Greece’s new government admitted the budget deficit would be double the previous government’s estimate, hitting 12% GDP. After years of uncontrolled spending and nonexistent fiscal reforms, Greece was one of the first countries to buckle under the economic strain.

It was also the first eurozone country to take a multi-billion pound bailout from other European countries (followed by Portugal and Ireland).

Fast-forward and Greece is still in a recession, more than a quarter of adults are unemployed, and the future looks bleak. Things don’t look any better in Spain, where the jobless rate is at 26%. The jobless rate in the eurozone as a whole is at 12%; the highest level since the euro was created in 1999.

If Greece fails to pay what it owes, the country will go bankrupt and most likely become the first country to leave the euro currency. Greece’s departure could open a floodgate with other countries following suit; thereby weakening Europe’s economic clout.

Today, the European debt crisis is on the brink of pulling the entire eurozone into a recession; dragging the global economy down with it. Ten European countries have already slipped into a recession and three more have needed to be bailed out in order to avoid going into default.

In March 2013, the government in Cyprus raided personal bank accounts to bail out the country’s financial system; setting a dangerous precedent. While politicians are saying this is a one-time event, one has to wonder if this tactic won’t be used again elsewhere. It’s not as if there isn’t just cause.

While Germany has been the economic engine for the eurozone, its slowing economy could join the rest of the region in recession. Thanks to the deep recessions in the other eurozone countries and austerity programs, Germany’s ability to carry the region is in serious jeopardy.

Germany’s central bank, the Deutsche Bundesbank, is predicting growth of just 0.4% in 2013; down from a June 2012 forecast of 1.6%. The Bundesbank also expects the jobless rate to hit 7.2% in 2013, up from 6.8% in 2012.1

That said, there is more to the European debt crisis than just debt. Despite a shared currency, the eurozone is made up of different countries with vastly different cultures, histories, philosophies, and economies. And those differences illustrate just how difficult it is for disparate countries to work together with one unified voice.

In fact, the head of the Bank of England referred to the European debt crisis as “the most serious financial crisis at least since the 1930s, if not ever.” 2

Sources:

1.         Thompson, Mark. “Germany may fall into recession in 2013,” CNN Dec. 7, 2012; http://money.cnn.com/2012/12/07/news/economy/germany-recession-warning/index.html.

2.         Elliott, Larry and Allen, Katie. “Britain in grip of worst ever financial crisis, Bank of England governor fears,” The Guardian Oct. 6, 2011; http://www.guardian.co.uk/business/2011/oct/06/britain-financial-crisis-quantitative-easing.