Why is the European Crisis So Much More Severe than the US Crisis and What Could Be Done to Fix It - Essay Example

?Why is the European crisis so much more severe than the US crisis and what could be done to fix it? Introduction The European economic crisis is thecurrent crisis afflicting a large part of the European community. This crisis has caused difficulties for countries transacting with the euro making it difficult for countries involved to repay their government debts without gaining the help of third parties. This crisis first manifested in late 2009 when the sovereign debt crisis was triggered by the increased levels of government debt around the world, and it was worsened by the downgrading of government debts for some European countries. Various causes of economic crises were seen for different European countries and all of these issues converged to form sovereign debts which were further increased by banking bailouts. In some other countries in Europe, their crisis was caused by private debts arising from the downturn of the property market. Greece was one of the countries which were significantly affected by this crisis. However, in general, the impact of the European crisis has been largely extensive. The impact of this crisis however seems to be larger and longer as compared to the US economic crisis as the US is now manifesting improvements in their economy. This paper shall discuss why the European crisis is so much more severe than the US crisis and what could be done to fix it. This paper shall present the primary aspects which make the European crisis much more significant in impact as compared to the US crisis. It shall also present possible solutions to this crisis. This paper is being carried out in order to establish a general discussion on the European crisis and to establish main points of this issue which can be used by scholars in order to create possible solutions to a lingering economic problem. Body One of the reasons why the European crisis is taking longer than the US crisis to resolve is the fact that the economy of Europe, which is under the European Union, includes 17 countries using one currency; moreover, the crisis covers a larger and more expansive economic bloc as compared to the United States (Koba, 2012). There are various states and various policies and sovereignties within this economic bloc. As compared to the United States, there is only one united ruling government and economy involved. In effect, any economic decision and government solution imposed by the US federal government is a decision which is meant to affect the entire country, not just a particular state (Koba, 2012). For the European community however, the crisis stems from a variety of causes for different countries and any solution to be implemented by the European community would be difficult to implement to all countries (Nelson, et.al., 2012). The European crisis is taking much longer than the US crisis to resolve because it is caused by various issues. These causes seem to include the following or a combination of the following: globalized finance, flexible credit option from 2002 to 2008 which caused high-risk spending, 2007-2012 global financial crisis, global trade imbalance, real estate crisis, 2008-2012 international recession, and bailouts of banks and private bondholders (Kakutani, 2011). All of these elements combined form the European economic crisis. In the last two years, the European Zone has carried out various considerations on how to handle their crisis. However, Greece, Ireland, Portugal, Spain, and even Italy have experienced a significant rating downgrade of their sovereign debt (Kakutani, 2011). This led to issues of default and a significant rise in borrowing costs. And, while this zone may be prompted to do whatever it would take to resolve the crisis, it would be unlikely for the situation to be resolved in the immediate foreseeable future. This crisis is not a classic currency issue (Sri Kumar, 2012). It is an issue which involves the management of economies in a currency zone, with their related economic and political issues arising from the fact that their citizens are doing business at a different pace (Blanchard, et.al., 2012). Varying fiscal capacities as well as debt profiles which are tied together by a single currency seems to be impacting greatly on the crisis. With the significant economic impact of the European zone to the global economy, as well as the gradual extensiveness being gained by the crisis, the point for seeking temporary and sedate solutions has past, and most of the European countries affected by the crisis have begun to realize this. The European crisis has become more protracted than the US economic crisis because most of the European countries within the Euro zone are still in a major crisis (Kakutani, 2011). Greece for example, which is said to contribute only about 2% to the Eurozone GDP is still in a major crisis and investors have already evaluated the power of member states to borrow with reasonable rates in the capital market (Sri Kumar, 2012). Along with Greece, Ireland and Portugal have also been prompted to accept bailouts established by the troika (EU, the European Central Bank, and the International Monetary Fund) (Sri Kumar, 2012). However, none of these countries have been able to provide strong global markets as was originally planned by the troika. Moreover, the bailouts have also placed these states in a state of continued recession and have not contributed much to the stabilization of the debt issue (Stevis, 2012). Such bailouts have also forced Spain to address their lower real estate prices, plummeting stock market, and the “flight of bank deposits” (Sri Kumar, 2012). The persistence of the European debt crisis is mostly attributed to two elements. The first element is that the lack of solvency in some of the countries involved in the crisis was treated as an issue of temporary liquidity (Sri Kumar, 2012). Secondly, there is a tendency of the crisis to affect one banking sector and then another, and then back again, thereby increasing the overall risk level (Sri Kumar, 2012). The EU economic authorities have continued to misdiagnose the problem to be one of liquidity because it seems to be the easier political option, and easier to provide liquidity via bailouts rather than to actually view it as an issue of excessive debt (Sri Kumar, 2012). This problem has also created the need for debt reduction options for countries in a crisis, leading to significant losses among creditors. In relation to the second element, in mutually supporting the impact of banking and sovereign risks, such situation and solution has traditionally caused deeper and prolonged debt crises situations (Sri Kumar, 2012). The European zone has yet to acknowledge the fact that adding liquidity to the countries in crisis would not fix the issue of excessive debts (Chudik and Fratzscher, 2012). If a country has debts amounting to a significant amount, extending credit to the country in order to help the country make temporary payments would not solve the issue. The country would only end up with an even bigger credit, and the bank would suffer even bigger losses in the future (Chudik and Fratzscher, 2012). Greece, Ireland, and Portugal suffered a similar dilemma with the troika. For Ireland and Portugal, their bailouts included the establishment of new funds from official creditors, with assurances that these states would eventually be able to access their private credit markets (Sri Kumar, 2012). However, this has not yet come to pass. Even when Greece’s debt restructuring included private creditors shaving off interest and face value, the capitalization interests in the years to come would likely keep the debt-GDP ratio at significantly high levels (Chudik and Fratzscher, 2012). All these states were significant borrowers in the international credit market until the economic crisis hit. Many creditors did not sufficiently consider the members of the countries in the common currency region, and willingly provided loans to these countries and to their banking sectors (Fratzscher, 2011). As the rise in debt has also caused consumer spending, the debt is presently too large to be supported and paid off by the public sector institutions. The European zone’s decisions in managing the solvency issue as if it were a temporary liquidity problem has only created a bigger problem in liquidity and in mounting debts (Fratzscher, 2011). The European economic crisis is also taking longer than the US crisis to resolve because the risk has changed with time, affecting the banking sector at first, and then impacting on the sovereign, and then back to the banking sector (Sri Kumar, 2012). This was seen in the case of Ireland where the government assumed the bank’s obligations after the latter experienced significant losses in 2008 up to 2009. Guaranteeing the bank debts stemmed the progression of the issue, but it also caused the Irish sovereign risk to rise to alarming levels, thereby leading to the country’s need for bailout (Gourio, 2010). For Spain, the banking system was affected by real estate loans which deteriorated in quality since 2006. Their debt yields also declined as their banks utilized funds from the ECB LTRO (European Central Bank Long term refinancing operation?) programs in order to secure sovereign paper (Sri Kumar, 2012). Their risk was not considered serious at first, however the recent concerns on Spain were prompted by the announcement of their Prime Minister that their fiscal deficit was higher than their expected GDP (Sri Kumar, 2012). Issues with Spain’s fiscal policy were also seen alongside signs that the recession was worsening and that the quality of the real estate loans would continue to deteriorate (Bussiere, Chudik, and Mehl, 2011). All these elements combined in the European zone add to the growing and prolonged European economic crisis, with clear solutions still not forthcoming to these economies. As this region is continuing to struggle, their issues are also affecting not just the rest of Europe, but the United States, and the global community as well. The globalized economy has created the scenario whereby most economies in the world are impacting on each other. The need therefore to establish clear solutions to these issues seems to have become more imperative. These solutions include the possible options as illustrated below. Possible solutions 1. Increased investments. The austerity measures being implemented in Greece is actually hurting, not helping it. Instead, the better option would deficit spending and tax increases (Kapoor and Boginger, 2012). As struggling European states do not have enough funds to participate in deficit spending, investors suggested provisions of 40 billion Euros to the European Investment Bank and the EIB could in turn invest ten times such amount to the smaller business sectors in the country (Kapoor and Bofinger, 2012). A renegotiation of EU savings tax directive to help manage tax evasion and avoidance was also suggested (Kapoor and Bofinger, 2012). 2. Increase competitiveness. The slow GDP rates are equated to slow growth rates and lower tax revenues, leading to more spending and increased deficits. In order to manage this situation, countries in crisis must increase their global competitiveness by internal devaluation, which is a painful economic adjustment with the unit labour costs usually reduced (Krugman, 2011). Ireland adopted such solution early this year and they were able to decrease their wage levels by 16%. Economist Jeremy Siegel (2012) pointed out that in order for countries in the crisis to gain labour competitiveness, they needed to devalue their labour. By devaluing their labour they can restore their fiscal balance and improve their external competitiveness (Siegel, 2012). 3. Resolve current imbalances There is also a need to resolve the current account imbalances of the countries in crisis. For countries with trade deficits, there is a need to manage their consumption and improve their savings habits (Krugman, 1998). In effect, if the citizens of the country were to save more and were to reduce their use of imports, they can reduce their trade deficits. Countries with significant trade deficits must therefore consume less and improve their exports (Krugman, 1998). For export economies with surplus, there is a need to adjust their economies towards their domestic needs and increase their wages to fund their domestic consumption. 4. Long-term solutions Long-term solutions seem to be an essential need for Europe, especially the European zone affected by the crisis. One of the proposed long-term solutions for this crisis is the establishment of a European fiscal union (Norris, 2012). Such integration would provide a centralized authority which would have higher and better control of the budgets of member states. Such control must only be imposed when there are fiscal and budget imbalances (Norris, 2012). This proposal would also increase the political and economic union among the countries and ensure more effective solutions to widespread issues. Eurobonds are also suggested as long-term solutions to the European economic crisis. Eurobonds issued jointly by the 17 member nations can help handle and manage the financial crises (EurActiv, 2011). They can help stabilize the economy; however there is a need to match this solution with strict economic monitoring and policy coordination in order to avoid moral hazards and to secure sustainable finances. The establishment of a European Monetary Fund was also suggested. This monetary fund would include the European bonds which would not be tradable but can be managed by investors for gradual liquidation (Schulmeister, 2011). This union would help provide support for financial investors and would also operate based on highly restrictive conditions while securing funds only to the countries which would be able to secure the fiscal requirements. Governments who do not have strong financial policies would be prompted to use traditional bonds which do not have much leverage in the market (Schulmeister, 2011). Through this union, the long and short-term interest rates would be stabilized and the GDP would be increased. Conclusion The European economic crisis is taking much longer to resolve than the US crisis because the European zone is made up of independent and sovereign economies which share a common currency. Solutions to this crisis may be forthcoming but implementing such solutions have been difficult due to significant barriers for each country in the Euro zone. The fact that the countries in the region have also treated the crisis like a temporary crisis has exacerbated the situation. The solutions which have been implemented have also been temporary and have only served to worsen the sovereign debt issues of the countries involved. Proposed solutions to this crisis included increased investments, increased competitiveness, balancing of trade deficits, increased spending, as well as long-term solutions in the form of Euro bonds and a European Monetary Fund. These solutions are generally aimed at improving their GDP and at increasing activity in their economy in the hope of eventually creating strong markets. Seeking a more united front for the European zone is also an important option which can be implemented because the current fragmentation of the Euro zone is making the crisis worse. By making the essential sacrifices now, the essential payoffs for these countries can be gained eventually and gradually. These solutions must also be long-term and permanent solutions which may be undesirable now, but effective and profitable in the future. References Blanchard, O., Dell’Ariccia, G., and Mauro, P., 2010. Rethinking macroeconomic policy. IMF Staff Position Note [online]. 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