Milestones of the European Sovereign Debt Turning-Point - Case Study Example

Task TABLE OF CONTENTS TABLE OF CONTENTS 2 The European Sovereign Debt Crisis during 3 Background of the Financial Crisis 3 GDP Growth in the Eurozone, Q4 2009–Q1 2011 4 Reasons behind the Financial Crisis 5 The Greece Crisis and Its Effects 6 The Fiscal Deficit, Total Expenditure, and Total Revenue (percentage of GDP) of Greek’s Economy 7 The Greece’s Current Account Deficit 9 Role of the Central Bank and the Spread of the Crisis 9 Kolb, Robert, Sovereign Debt: From Safety to Default, Canada: John Wiley & Sons, 2011. 13 Print. 13 13 The European Sovereign Debt Crisis during 2010-2011 Background of the Financial Crisis The ‘Sovereign Debt Crisis’ is a serious havoc in the securities’ global markets, which make it difficult for universal “European Monetary Union” associates, to fund their budgets (Viana 2). Matters involving liability crisis have in the recent years being reported globally, as the level of the sovereign arrears of some of the financial scheme of the world have risen, giving them a threat of failure to pay. A Financial network is thought to be in an obligation crisis once its government has failed to pay its debt. However, not any of the nations that are at present in debt disaster has defaulted, but they involve extremely high government debt balances, and their bond output spreads in the securities of the government have gone up, as a result, there is relegation of their sovereign ratings for credit. When an area suffers this crisis, it might be able to undergo a sudden discontinue of inflows from the foreign capital because of major loss of capitalist confidence regarding the economy. The Eurozone had kept an overall acceptable short-term financial credit between 1999 to the year 2007. However, there existed large as well as continuing inequities in the region. “Greece, Spain, Portugal, and to a lesser extent Ireland”, sustained massive current account shortfalls, and Germany, Netherlands, along with Luxembourg, had profits in the account (Braga & Vincelette 222). The providers of the large plus extended current account losses are dissimilar across these countries. As years went by, the deficits balances of the current financial standing have been increasing, also, a decrease to the surpluses in the other countries. The existing crisis on debt commenced with the demise of the banking corporation in Iceland in the year 2008, and spread to some of the countries in Europe like the Ireland, Portugal, as well as Greece in the year 2009. At the beginning of the second half of this year, reports concerning the debt crisis on the United Sates also blew up (Economic Review 1; Braga & Vincelette 222-225). The crisis originated from various factors and had tremendous implications to the economy of the European countries. GDP Growth in the Eurozone, Q4 2009–Q1 2011 (Belkin, & Mix, & Nelson, 14) Source: International Monetary Fund, World Economic Outlook, April 2011 (Belkin, & Mix, & Nelson, 4). Reasons behind the Financial Crisis The debts predicaments are featured to pro-cyclical economic policy in the period preceding the economic crisis. The countries impinged on had being managing large and untenable fiscal deficits for several years, largely funded through borrowing. The Government of Greek used deficit spending to increase extraordinarily, the people’s standard of living as the debt funded the joblessness societal benefits, raised the remuneration of public workers along with pensioners’ income, and sustained a mutually respectful labor market. The evident cause of the “European Debt Crisis” is also the changing of the ‘European Monetary Union’ (EMU) from financial stimuli to fiscal consolidation in the year 2009. Until that year, the EMU together with the entire European Union (EU) and other main financial systems followed the IMF order in the upshot of Lehman Brother’s insolvency, to promote global demand by way of increasing government spending. The European Central Bank (ECB) alleviated the strategy by lending to banks without limits. The philosophical root of the adversity was the competition between the euro and the US Dollar. The competition commenced in the year 1999, so that the practicable to be cashed by international traders as a desired reserve currency. The rivalry increased during the international crisis; a crisis that erupted in the Wall Street, the Headquarters of the dollar area. Then, the Dollar was pointed as a reserve coinage at the global level, by the “Bretton Woods Conference”, in exchange for Gold. The United States’ monetary program ran outdoor profits effectively, and US financed the others. The main objective was for the US, to develop a reputable fiscal position. However, the financial system of the United States began to manage increasing deficits before it built up steady fiscal position. Therefore, dollar surpassed the global requirement for business purposes. An era of worldwide inflation ensued in 1970s, and then the gold exchange norm ended, along with the attached exchange charges as rendered in the year 1944. In the year 1981, when the US president unexpectedly altered the strategy, its outside deficit increased. The backing transformed and instead of transmitting dollar overseas to disburse for the shortfall, the US rented immensely by way of disbursing high rates of interest. Because of the increased rates of interest, there came about an enduring global recession. The recession ended in the year 1985, and at that time, the United Sates benefited from a high acquisition power in countries like Japan and Germany. In 1990s, the Europeans emanated the euro as a general coinage, and Germany and it appeared as a sign of the European Union. Moreover, the euro was supposed to be a necessity to promote the economic unification. The euro presented global exporters with a reserve currency of high inherent value; therefore, it was meant to substitute the dollar, in control of money balances. The rivalry among the currencies set in motion, and it continued easily from 1999 to the year 2007. Pushed by the feisty advantage of the euro; Wall Street outshined in fiscal production. It then endeavored to proffer the worldwide exporters remarkable assets to invest their profits. The procedure of union, requisite to every nation to join the general currency was anticipated to guarantee accomplishment, but it did not, which led to the current crisis. Beside the background, the fiscal crisis was the inevitable product of inflation of US dollar denominated investments. The crisis broke out of the supreme loan-secured guarantee and “Collateralized debt obligation” (Viana 4-21; Grauwe 11-13). The Greece Crisis and Its Effects One of the weakest economies in the Eurozone that caused the crisis because of its enormous debts is Greece, which has a small financial system of only 2.4 per cent of the entire GDP of Eurozone. However, Greece has been the core of the crisis in Eurozone, and the consequences of its crises are extensive (Belkin et al 11). This is because; it has the uppermost amount of public arrears in the zone and is among the leading financial plan deficits. It was the earliest member of Eurozone to appear under strong forces of the market, also, the first to go to other Member states of Euro area and the IMF for monetary support (Belkin et al 6). There were various motives behind the crisis in the country. One of them was the Global downturn that resulted from the fall of the United Sates Subprime. This had caused tension in the country’s finances as expenditure raised and tax income decreased. Secondly, it also resulted from the raise of budget shortfall as well as the country’s public liability. In addition, the issue of evading tax due to weak revenue collection contributed to the crisis. Another reason was the government higher expenditure, which increased its debts annually. The Fiscal Deficit, Total Expenditure, and Total Revenue (percentage of GDP) of Greek’s Economy (Armanious 3) In addition, Greece had the highest current account shortage every financial year, which came because of its poor spending. Lastly, the Greece government misreporting of their economy statistics to be within the guidelines of the monetary union was also a cause for the crisis (Armanious 2-6; Beltran et al 4). The dependence on borrowing from intercontinental capital markets, to disburse budget, as well as trade shortfalls, left the government of Greek at risk to change in the confidence of the investor. Although a reform agenda was proclaimed in 2010, it was not on time to influence the market; therefore, Greece found itself disconnected from the global fiscal market. Confronted with the bankruptcy in April 2010, the authority of Greek asked for monetary support (Visvizi 3). This crisis in Greek can result to immense implications for the United States’ fiscal market. This is because; the joint fiscal correlation between the United States and the EU is among the well built, also, the largest worldwide. Thus, economic tumult in Greece, as well as the wider Eurozone, would have depressing repercussion for the financial system of the United States. The crisis severity measures may reduce Europe’s growth and cause loss of trust in the euro, leading to lessening of the euro comparative to the US dollar. All these issues will slow down the United States exports’ demand to the Eurozone as well as raise its imports from the Euro area, resulting to the widening p of the US trade shortfall. The reduced rates of development in Europe may possibly cause shareholders of the United States to consider increasingly, the upcoming markets for chances to invest. However, when the euro is weak, it will make the stocks, as well as assets of Europe; seem more economical and attractive, thus, drawing the capital of the United States towards the Euro area (Belkin et al 14). The Greece’s Current Account Deficit (Armanious 5). Role of the Central Bank and the Spread of the Crisis The central Banks played a significant part throughout the period of crisis. For example, The European Central Bank (ECB) gave unparalleled sums of liquidity financial support, which permitted banks with harsh solvency difficulties to meet their obligations to the ‘private bond market’. For instance, The Irish banks paid off the majority of their bond arrears, which were due at the beginning of the economic crisis, through the support of the ECB, as well as the Central Bank of Ireland (Whelan 6). In a debt crisis, the Central Banks plays both the role of defender of cost stability as well as exerciser of accountability for the easy running of the economy (Kolb 17). For instance, The EU Central Banks reacted resolutely to the growing anxiety of the capital markets following the fall of Lehman Brothers. The Bank of England, ECB, as well as additional non-EU Banks, reduced the costs of borrowing to help deal with the pecuniary difficulties (European Economy 65). Several measures were been taken to reduce the crisis, but it continued to spread widely to other countries in the Euro area. In around May of 2010, the crisis exacerbated in Europe, and then in November the problems extended to Ireland. In addition, Portugal submitted an application for the EU’s financial support on April, since it was experiencing a political failure as well as rising difficulties to pay for its debts. It has been contemplated that Spain will as well require a rescue like that of Ireland, Portugal along with Greece to balance their applied austerity procedures (Beltran et al 13). Although several measures are suggested to curb the situation, the best way could be the use of the portfolio theory or the ‘Capital Asset Pricing’ replica developed by the World Bank. The ‘Capital Asset Pricing Model (CAPM)’ is a model that argues that when the risk-averse features of agents are provided, they solely concentrate on the mean, as well as the variance, of their income. Mostly, investors prefer Portfolios to reduce the returns’ variance, which is the rate of risk, for certain expected revenue and capitalize on projected returns of a specified risk. The CAPM examines the connection between revenue with risk in terms of market equilibrium. This model implies that, the representatives of portfolio optimizing get together in the market, and the interface limits the costs to the equilibrium of the market, and they concur on the joint allocation of the return of assets. The CAPM model suggests that, the asset’s return above that of an asset free from risk like the government bond, which is the asset’s premium, is comparative to Beta statistic. Beta is “a measure of the elasticity of the rate of returns of an asset with respect to that of the market, which is its systematic risk” (Caldentey & Vernengo, 4). Therefore, it means that assets having high systematic threats contain a return which is high than of those assets containing a less systematic threat, and assets having similar systematic risk must provide equal returns. This model is significant in that it permitted the financial markets to measure the portfolio’s risk. Therefore, the EU countries should deal with the risk of the debt portfolio by simulating the service flows of cash upcoming liability. The simulation will primarily give a projected pathway for future obligation service that is linked with the concept of price. It will as well recognize the prospective divergence of arrears servicing flows from that projected trail because of shocks in exchange along with charges of interest, or lack of loan able finances in the internal or else the global markets, presenting an appraisal of risk. This function will let the banks evaluate varied strategies, assess the cost-risk exchange, and then choose a debt policy that well again reflects the goals of the government as well as its ability to bear the risk (Velandia 8). This would reduce the rate of debt deficits in the region. In conclusion, the ‘Sovereign Debt Crisis’ was as a result of several factors and had a massive impact to the European economy. Therefore, proper measures should be put into practice, in order to deal with the crisis. Works Cited Armanious, Amir, The Sovereign Debt Crisis in EU and MENA: Mechanisms and Challenges, 2011. Accessed at: Read More