The European Debt Crisis - Research Paper Example

? Outline Introduction i. Thesis ment ii. Discussion iii. Causes iv. Solutions v. Effects of the European Debt Crisis 2. Conclusion 3. Works Cited The European debt crisis, can the world ignore it and keep it European? 1. Introduction The European debt crisis brings as a result of how Europe had made an attempt to solve the financial crisis faced by most countries and as a result an immediate end in their prosperity and put them in great debts. In an attempt by the European to defend itself against collapse has created a new crisis untenable and into debts that are not easily serviceable. Most of these outcomes are as a result of the stimulus packages that were passed by the European governments in an aim to stop the economic crisis that is taking place in Europe1. Most the European governments have spent a lot of resources on the stimulus packages in an attempt of preventing themselves from great collapse but have in turn created a debt crisis2. i. Thesis Statement With reference to the discussion question given, this paper will analyze if the world can afford to ignore the European debt crisis and leave it to the Europeans. It will also analyze the causes of the crisis and what the European governments are doing to try and solve the impending crisis which is threatening to destroy the prosperity of the European countries which have been economically stable as compared to the rest of the continent. ii. Discussion The world cannot ignore the European debt crisis because the European countries came into these debts as a result of trying to solve the financial crisis that many countries were facing at the time. This debt crisis has made so difficult for most of the European countries to finance the debts that are owed by their governments without any assistance from the outside world. By the end of 2010, over 90 of the biggest banks in Europe had lent over 760 Euros to countries like Ireland, Portugal, Italy, Greece and Spain. Due to this, the bank system in Europe is on the verge of recession. Every attempt at being made to save a bank system that is struggling with that, the same banking system had lent a lot of money to governments. Despite the financial crisis that is being faced by European governments that Euro has managed to remain stable on the financial market although many financial analysts have predicted of its loosing of strength against all the other market currencies3. In November 2011, it was seen that the Euro was trading slightly higher in the financial market than it was at the beginning of the financial crisis. Three countries that were most affected by the financial crisis were Greece, Ireland and Portugal. These three countries account for 6% of the Eurozone’s gross domestic products (GDP) collectively4. iii. Causes The European debt crisis was caused by the financial markets and other financial institutions which were greedy and blind in terms of the eurozone. In addition to that, there was the adoption of the Euro which led to the biggest drop in the interest rates and a lack of confidence from financial institutions to the European governments5. The domestic demand for finance also went very high which in turn cause a surge in the financial sector and in turn caused the a crisis. The growth of the Eurozone countries which was driven by the services offered domestically and construction was accelerated while the export industry in these countries remained in the same position thereby causing abundance in the foreign capital invested in the Eurozone countries. When European countries went to save the globe from a financial crisis, the European countries ended up with debts that the governments cannot afford to pay for. In the meantime as this looming crisis was at hand, Germany was transformed in a historic transformation to become one of the world’s largest exporters6. There was also excessive lending by financial institutions which led to a loss of competitiveness due to the unsound economic developments in several Eurozone countries for many years. The launch by the European Central Bank of a monetary union was an actual link. This monetary union was a combination of the monetary policy in the Eurozone countries and a decentralized fiscal policy in the same Eurozone countries. When the monetary union was being established by the European Central Bank, the severance debate was already at the centre of debate. The monetary policy that was introduced by the European Central Bank was highly enjoyed by the countries with the biggest boom7. In 2002, there was a change in the economy of Europe when 16 countries from the Eurozone began using the Euro as their monetary unit. As a result interest rates in Ireland soared up high. In addition to that, the prices of homes went very high and as a result of this many home buyers had to borrow huge amounts of money from the financial institutions8. The home buyers who had borrowed the huge amounts of money from the financial institutions could not afford to return the loans which created a huge instability in the banking system in the Eurozone countries. This forced the government to have the reality that the financial institutions would be crippled if the debtors could not afford paying up their debts. This in turn sparked a financial crisis in the Eurozone countries. In addition to that, the financial institutions in the Eurozone countries had a lot of stress due to defaulted loans by their debtors and in turn financial institutions had to continue extending their payment dates and thereby making them not approve any other loans by home buyers to buy homes. There was also huge bailout by the Eurozone government which in turn meant that the governments had to spend large amounts of money trying to save the financial institutions which were suffering as a result of debtors defaulting on payments9. After the government bailout, some of the Eurozone countries had problems trying to pay back their debts in that they had very huge debts. Such Eurozone countries included Greece which was at the time having difficulty in trying to pay out the debts owed. As a result, the economy of the Eurozone countries continued to deteriorate and investors started pulling out of the Eurozone countries10. This led to a fall in the stock market as consumer confidence went down and in turn consumers had to stop spending and the financial institutions had to stop lending which led to the financial crisis that is being faced by the European countries11. iv. Effects of the European Debt Crisis The European debt crisis has a significant effect of the non-Euro area banks which sought to reduce their holdings in the Eurozone bonds. In addition to that these financial institutions reduced their deposits in the European Central Bank. The debt crisis that was facing the European countries had several effects to the rest of the world which included; the crisis lowered the growth rate of the Europe which was a market of over a quarter of the exports that the rest of the world export. The European market was the biggest and accounted for a quarter of the export market and thereby by the crisis that was facing the European countries, this meant that this market was out of bounce for exporters who exported to the European market. The other effect of the European crisis was the continued depreciation of the Euro in the financial market in that there was reduced income from exporters who did not import their produces. The European debt crisis also kept the policy rates very low in the Eurozone countries and other developing countries around the globe. As a result of this there was a surge in the emerging financial markets around the globe12. The debt crisis was also a very serious blow to the financial institutions in the Eurozone in that most of them were on the verge of bankruptcy. Some of the financial institutions had loaned out huge sums of money and had no collateral on the loan thereby making them lose a lot of money when the loans were not paid back by the home buyers. The other effect of the debt crisis is that it raised an alarm over the European debt that the European countries own the financial institutions13. v. Solutions Several emergency measures have been put in place in place by the European Union in a bid to try and resolve the financial crisis that is facing the European governments. The measures that were put in place by the European Union include the European financial stability facility (EFSF). This facility was created in May 2010 when the 27 member states of the European Union met and agreed to create it. This is a legal facility that was mandated with the preservation of the financial stability in Europe by assisting the Eurozone states that are in difficulty financially. This facility has the mandate of issuing bonds and other debt instruments with the support of German Debt Management Office in an aim of raising the funds that are needed by the Eurozone countries that are in financial troubles to provide loans or help paying the debts14. In addition to that, the other measure that was put in place was the reception by financial markets. After the European Union announced about the formation of the European financial stability facility (EFSF), stocks surged worldwide. The European financial stability facility (EFSF) eased fears that the analysts had predicted that the Greek financial crisis was likely to spread across other countries and as a result making the stocks of financial markets rise to very high levels witnessed in over a year. The Euro on the other hand rose to its biggest gain in one and a half years in the financial markets and a week later fell to lows never witnessed in more than four years. It was just for a short time before the Euro rose again as a result of traders using the currency in short positions and carry trades. Following the announcement, the prices of most commodities rose. On the other hand the dollar remained at a nine-month high. The other emergency measure put in place by the European Union is the usage of the European financial stability facility (EFSF) funds. Although the European financial stability facility (EFSF) only raises funds when a request is made by a specific country for aid, by December 2011 it had been activated twice. In November 2010 it was activated by a request by Ireland and it financed Ireland with 17.7 billion Euros out of the total 67.5 billion Euros. In May 2012 it was activated again by Portugal and financed it with a third of the total amount which was 78 billion Euros. The term of the European financial stability facility (EFSF) is set to expire in 2013 after which the member states are scheduled to ratify the capital commitments of the European Stability Mechanism (ESM) and thereafter implement it15. Another emergency measure that was put in place by the European Union is the European Financial Stabilization Mechanism (EFSM) that was created in January 2011 by the European Union. This in an emergency funding program that relies mainly on the funds guaranteed by the European Commission and rose upon the financial markets using the budget of the European Union as its security. This mechanism runs under the supervision of the European Commission and has been mandated with the task of preserving the financial stability if the European governments by providing European Union members with financial assistance in times of difficulty. The European Commission which is backed by all the 27 European Union member states was given the authority to rise up to 60 billion Euros and was rated AAA by financial analysts. In a bid to promote financial stability of Europe, the European Union leaders of the 17 Eurozone countries met in Brussels in October 2011 and agreed that 50% of Greek sovereign debt write-off held by financial institutions. They also agreed to increase the bail-out funds held under the European Financial Stability Facility to about 1 trillion Euros. In addition to that they agreed on an increase mandatory level of 9% for bank capitalization within the European Union. They also set commitments for Italy to take necessary measures to reduce the country’s debt. The pledges in credit enhancement to moderate the losses that were being suffered by the European banks were 35 billion Euros. In a meeting held in February 2012, the European Union agreed with the International Monetary Fund and the Institute of International Finance on the conditions that were to cover the second phase of the bail-out process which was worth 130 billion Euros16. Other solutions include the European Central Bank (ECB) intervention which has taken several measures to reduce the tension in the financial markets and improving the financial stability of the Eurozone countries. In a bid to stabilizing the financial markets in Europe, the European Central Bank (ECB) began opening market operations by buying government and private debt securities that reached up to 219.5 billion Euros by February 2012. It also changed its policy with regards to the necessary credit rating for loan deposits. They also changed a policy with regards to collateral of outstanding and new debt instruments issued by the Greek government. They also reactivated the swap lines for the dollar with the support of the Federal Reserve. In December 2011, the European Central Bank (ECB) started an infusion of credits in the European financial institutions that was the biggest in 13 years17. So as to improve the financial situation in the Eurozone countries, the European Union increased the international competitiveness by depreciating the Euro in the countries that were affected by the financial crisis between 2008 and 2011. Since Eurozone countries cannot depreciate the value of their currency, leaders of the European Union are trying to restore competitiveness through an economic adjustment process. This economic adjustment process is aimed at reducing the unit labour cost in the Eurozone countries. Some financial analysts say that no matter how much some of the Eurozone countries such as Greece and Portugal reduce their labour unit costs, they will never be able to compete with other developing countries such as China or India. It is being proposed that the weak countries in the Eurozone must then be able to produce quality products and services though they do not expect this to bring an immediate relief to the Eurozone this being a long-term process. A big number of the Eurozone investors say that the Eurozone would be the best solution to the debt crisis that is facing the European countries by will require several changes in the European Union treaties18. Regardless of the emergency measures taken by the European Union in a bid to save the continent from the current financial crisis, the current account imbalances are most likely going to continue for a while longer. It has come to a point where the only way to solve the crisis in Europe is for individual countries to lower their budget deficits and to change the current consumption habits and saving habits. It has therefore been proposed that countries that have large trade deficits e.g. Greece, should consume less ad improve on their export sector to earn more in the form of foreign currency so as to reduce the budget deficit. It has also been proposed that countries that rely more on the export sector such as Germany and the Netherlands should shift their economies from the export sector and lean more towards domestic services and increases earnings to support domestic consumption. For the Eurozone to reach a sustainable level, it must be able to reduce its overall debt level by 6.1 trillion Euros according to financial analysts19. 2. Conclusion In conclusion, the world cannot afford to ignore the financial crisis being faced by countries in the Eurozone because when the debt crisis emerged in early 2010, it dominated headlines, and as a result roiled the world financial market. As a result this kept investors at bay and this cost the Eurozone countries billions of Euros in revenue. For favourable results in trying to preserve the financial stability of the European countries, the governments must implement the emergency measures that have been passed by the European Union in a bid to trying to save the situation as regards to the financial crisis. 3. Works Cited Barnabas, Cristobal. European Sovereign Debt Crisis. London, UK: John Wiley and sons, 2011. Print. Carlos, Alberto. Sovereign Debt and the Financial Crisis: Will This Time Be Different? New York, NY: World Bank Publication, 2010. Print. Heinz, Duthel. European Debt Crisis 2011. New York, NY: Epubli, 2011. Print. Matt, Buttsworth. Democracy and Debt - the European Debt Crisis. California, CA: Matt Buttsworth, 2011. Print. Matthew, Lynn. Bust: Greece, the Euro and the Sovereign Debt Crisis. London, UK: John Wiley & Sons, 2010. Print. Rabah, Arezki. Sovereign Rating News and Financial Markets Spillovers. Washington, DC: International Monetary Fund Publications, 2011. Print. William, Cline. Resolving the European Debt Crisis. Oklahoma, OK: Cengage learning, 2012. Print. Read More