The European Sovereign Debt Crisis - Research Paper Example

Contents Introduction 3 Causes of the European Crisis in Greece 4 Market Problems and Liquidity 4 European Debt 4 Economic Fundamentals and European Public Debt 5 Sustainability in Debt 5 Issues with Collective Actions 5 Political Systems 6 Hazards due to the Debt Crisis in Europe 6 The Current Financial Condition in Europe after the Crisis 8 Conclusion 10 Works Cited 11 The European Sovereign Debt Crisis Introduction The European deficit crisis refers to the inability of some European countries to pay off their government debt without third parties having to intervene. According Schäfer (1), the causes of such a crisis varied from country to country. The crisis brought about serious economic and political effects on most countries. The debt crisis affected a number of countries like Portugal, Greece, Spain, Italy and Ireland among others. In the year 2001, Greece joined the EU (Schäfer, 1). Greece had to pay a return rate that was higher than the fiscal market. Originally it was to decrease its debt to obtain a standard rate of fiscal debit in order to join the EU. After a while, the deficit rate became enormous, thus leading to the rise of the sovereign debt crisis in the year 2009. Therefore, it is arguable to state that is the starting point of the European debt crisis. This paper will attempt to look at the causes and effects of the European debt crisis. How Greece became the origin and what other countries were affected by the situation. Finally, the current state of Europe after the debt crisis shall be analyzed. Greece had one of the fast growing economies and as a result had a massive deficit. As the global financial crisis came to pass, Greece was greatly affected. This was evident especially on the country’s largest industries (tourism and shipping industry). This led to lump sum spending to keep the economy going, but instead the sovereign debt increased with each passing day. With increased borrowing from the International Monetary Fund and the European Union, the Greek government was problem bound. Greece registered a debt of five hundred and forty billion dollars (Stein, 1). This is one hundred and twenty five percent of its Gross Domestic Product. Despite Greece making one or two mistakes, there were other factors that led to the crisis in Greece. External debts of Europeans states are at the center of the recent crises. In general, the debt crisis is associated with the budget deficits being in excess of the values provided by the Maastricht Treaty, and the Stability and Growth Pact (Ludwig Von Mises Institute, 1). These groups only focused on debt and deficit ratio ignoring external debts. Consequently, the laws governing the European Central Bank do not allow single investors and creditors to borrow government bonds in case of a crisis. Eventually, the debt crisis became alarming as the country decreased public benefits (Greece froze civil service salaries and in turn raised taxes and retirement ages). Causes of the European Crisis in Greece Market Problems and Liquidity States retained their control of the budgets, even though, the Maastricht Treaty centralized monetary policy. This enabled the government to watch over the fiscal policy of the state, but with time it was evident that this mechanism had failed. Stein (1) claims that, markets underpriced the default risk. The credibility of the Stability and Growth Pact would be at jeopardy because of the inability to determine the actual deficit. European Debt Due to the unsustainable nature of the debt crisis, major world markets fear that debtors in Greek Land and all around Europe would default. It is evident that most European countries accumulate debt due to their irresponsible manners or behavior. Problems with debt are often caused by lack of competitiveness and anomalies that need orthodox macroeconomic fine-tuning. Therefore, fastened fiscal policies and strict actions are needed to bring things back to normalcy. Economic Fundamentals and European Public Debt Problems with deficit in Europe were as a result of the long run debts that were not corrected early enough, regardless of the existence of the Stability and Growth Pact. After the global crisis, these issues turned into sensitive matters regarding the national debt crisis (Stein, 1). Debt levels were pushed up as a result of the global recession. Fundamentalists have often blamed the lack of proper discipline in fiscal policies, eventually ignoring and underestimating the significance of the global financial predicament for the Euro debt crisis. Finally, using only the deficit and debt rations can produce misleading facts hence mistaken policies should also be taken into account as contributing factors towards the debt crisis in Europe. Sustainability in Debt Due to the hostile nature of debts growths would decrease, defaulting risks would rise, and interest rates would rise hence, lowering growth. Lane (56) recommends that this cycle should then be evaded by increasing the length of the fiscal policies over a given period. In addition, finances are stable and sustainable given that crises that caused interests to rise above sustainable levels should be avoided. Debt is sustainable provided policies fail. Issues with Collective Actions Provided authorities do not correct the problems present by buying off the excess securities, financial asset pricing would collapse leading to a non-functional banking system. A conflict of interest occurred between the authorities and the private sector (Stein, 60). Political mismanagement has scared off investors hence countries are unable to raise funds to cope with the debt crisis. Political Systems Decisions made on political grounds have often been at the core of Europe’s problems (Lane, 50). The crisis is in a real sense a political crisis. Political constraints have for a long time restricted requirements for a single currency among numerous states. Hazards due to the Debt Crisis in Europe As mentioned earlier, the European sovereign debt crisis has been in existence for the past two years. It all started with looming questions of Greece’s capability to service its increasing debts (Christensen, 1). It is imperative, therefore, to note that the Eurozone is still suffering the effects of the debt crisis despite establishing initiatives to bail it out (Schafer, 182). This has thus resulted into various hazards or rather effects which are of course due to the crisis. As much as significant impacts of the debt crisis have been felt by Europe, the situation has been cross cutting across the globe. Generally, the Europe investment capacity and investment have significantly weakened. This unforgiving situation has resulted into various investors around the world opting to purchase the US bonds and currency as well. It so happened that by the time the debt crisis was hitting the Eurozone, the United States was recovering from the global financial crisis as much as its economy had significantly contracted at the time. Consequently, investors maintained confidence, as regards investment, in the United States’ economy. This is evident by the US bonds and the exchange rate as well. As a result, the dollar (USD) has increased in value as compared to the EURO. The Euro’s depreciation symbolizes the adverse effects of the crisis on Europe. On the other hand, the strength of the dollar has had its effects in the sense that these goods become less competitive on the market. This effect works to minimize the country’s exports in addition to slowing down the growth of the economy. Furthermore, the efforts have tremendously reduced due to the relatively reduced demand in the Eurozone. It is worth noting that the US has made significant steps in line with recovering from the global financial crisis. However, these steps have not been as robust due to the European crisis. Japan has also emerged as a haven during the European crisis. However, the relatively high value on its currency has equally resulted into problems (Christensen, 7). The country’s economy has since been hurt due to the less attractive exports bringing its economic stability to question. The European debt crisis has also had its effects on emerging economies around the world. Reports suggest that quite a number of emerging economies recorded relatively high levels of growth in 2010. Consequently, this development attracted more investors into the fast growing emerging markets. It did not take long before these attractive markets began feeling the adverse effects of the European crisis. The US took stun measures such as tightening credit while anticipating the economic meltdown in the coming days. The European debt crisis resulted into a significant reduction in the volume of Chinese exports leading to the country’s (China) reevaluation and restructuring of its economy. The crisis hit hard on China’s fiscal and monetary policies. Drastic measures such as tightening the respective policies had to be implemented. This was in anticipation of high rates of inflation rates that come after high levels of economic growth. The European Union consumes a whopping 20% of china’s exports (Christensen, 10). This was affected by the reduced demand from the Eurozone. The issue of tightening monetary policies in order to survive the European debt crisis has seen a reduced economic growth in Brazil. Just like the United States and Japan, Brazil has also suffered due to reduced demand for their exports. China is the leading exporter of Brazilian commodities. This means that a prolonged situation of the debt crisis affects china and in turn Brazil. Brazil as a country resorted to ‘helping’ itself rather than combining resources with India, China, Russia, and the US to bail out the Eurozone. India’s economy has also been hurt by the crisis in light of reduced foreign investment. In addition, its economic meltdown has been substantially influenced by decreased domestic spending. The effects of the crisis on India were immense since the European Union more direct foreign investment in the country as compared to others. The obvious results point towards a decrease in value of the national currency (Indian rupee). On the contrary, the reduced value of currency enhanced its exports. The Current Financial Condition in Europe after the Crisis 2012 has witnessed quite a number of protests as well as “election losses against austerity measures” (Ludwig Von Mises Institute, 1). Apparently, European nations have not worked on austerity policies. They have instead banked on cutting deficits by increasing taxes. In January this year, the Greece’s government moved to inform the country of a possible measure to pull out of the Euro if at all the situation persisted. It also proposed the use of posterity measures that would work to ease the country out of the situation. The government’s failure in the May 2012 elections compelled the EU fraternity to quickly consider Greece’s exit from the union. Upon implementing austerity measures, Iceland began ripping the benefits of such a move. This was evident through the positive growth in the area of real wages for instance. It is imperative to note that the country has since exhibited clear signs of recovery on the basis of stabilized inflation rate. A recent survey forecasted that Portugal would not be in a position to borrow funding at relatively sustainable rates up to 2013 (Ludwig Von Mises Institute, 1). July this year witnessed a turning point when the country’s prime minister revealed of the government’s initiative to incorporate austerity measures. Spain has since resolved to cut on its rates of borrowing in addition to introducing a comprehensive bond-buying program. The country has since moved for a European rescue for the various banks as a bailout program. Conclusion The European crisis has for a long time affected different countries including Spain and Portugal. The crisis has political, economic and external effects and policies that led to the development and increase of the debt crisis in Europe. With fast growing debts hazards are inevitable. For instance, crisis in the euro zone affected the demand for products by other states decreased markedly, it was not possible for Europe countries to borrow and hence the export business is facing a crisis (Lane, 55). Months after the crisis, countries in Europe have not considered implementing austerity measures but have instead resorted to increasing taxes as well as increasing the retirement age to cover the debt owed by the state or government. Works Cited Christensen, Tim. “The Global Effect of the European Sovereign Debt Crisis”. 07 Apr. 2012. Web. 09 Dec. 2012. Pp. 1-19. Lane, Philip. “The European Sovereign Debt Crisis.” Journal of Economic Perspectives. Vol. 26, 3(49–68). Ludwig Von Mises Institute. “European sovereign debt crisis (2010-present).” 26 Aug. 2012. Web. 10 Dec. 2012. Schafer, Hans-Bernd. “The Sovereign Debt Crisis in Europe, Save Banks Not States”. The European Journal of Comparative Economics, 9.2 (n.d): 179-195. Print. Stein, Jerome L. "CESifo Forum‎." CESifo Forum, 12 Jul. 2012. Web. 10 Dec. 2012. Read More