THE EUROPEAN DEBT CRISIS

The European debt crisis isnt actually a crisis in every European country. Instead, the crisis is limited to a few nations. In particular, the nations with the most concerning debt are: 1. Portugal 2. Ireland 3. Italy 4. Greece 5. Spain These five nations are also known as the PIIGS, a term which was coined for the sole purpose of identifying easily the five countries in the worst economic shape. Most of these nations are indebted to a degree that makes it difficult to recover. The concern is that the PIIGS have so much debt that their interest costs will eventually be so large that they wont be able to spend in other places. Eventually, debts grow to be so large that the countries cannot pay their debts, cannot make good on social programs, or have to risk default in order to balance their budgets. HISTORY From late 2009, fears of a debt crisis developed among fiscally conservative investors concerning some European states, with the situation becoming particularly tense in early 2010.This included euro zone members Greece, Ireland and Portugal and also some EU countries outside the area. In the EU, especially in countries where sovereign debts have increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany. In 2010 the debt crisis was mostly centred on events in Greece, where the cost of financing government debt was rising. On 2 May 2010, the euro-zone

countries and the International Monetary Fund agreed to a 110 billion loan for Greece, conditional on the implementation of harsh austerity measures. The Greek bail-out was followed by a 85 billion rescue package for Ireland in November, and a 78 billion bail-out for Portugal in May 2011. . On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth 750 Billion (then almost a trillion dollars) aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF).

CURRENT SCENARIO In May 2011, the crisis resurfaced, concerning mostly the refinancing of Greek public debts. The Greek people generally reject the austerity measures and have expressed their dissatisfaction through angry street protests. In late June 2011, the crisis situation was again brought under control with the Greek government managing to pass a package of new austerity measures and EU leaders pledging funds to support the country. National debt, put at 300 billion ($413.6 billion), is bigger than the country's economy, The country's deficit -- how much more it spends than it takes in -- is 12.7 per cent.

THE REASON: Years of unrestrained spending, cheap lending and failure to implement financial reforms left Greece badly exposed when the global economic downturn struck. This whisked away a curtain of partly fiddled statistics to reveal debt levels and deficits that exceeded limits set by the euro-zone. But why Greece? Though it is only 2.6% of euro-zone GDP, Greece sounds three warnings that reach far beyond its borders. The first is economic. Greece has become a symbol of government indebtedness. This crisis began last October when its new government admitted that its predecessor had falsified the national accounts. It is labouring under a budget deficit of 13.6% and a stock of debt equal to 115% of GDP. It

cannot grow out of trouble because of fiscal retrenchment and its lack of export prowess. It cannot devalue, because it is in the euro zone. And yet its people seem unwilling to endure the cuts in wages and services needed to make the economy competitive. In short, Greece looks bust. Even though Athens is pursuing reform with surprising gusto, investors have re-focused on the fact that there is near consensus among economists and financial analysts that Greece's debt is simply unsustainable, whatever measures the government may take. If that proves true, then a restructuring of the debt is inevitable, which would forces losses onto bondholders. Those fears are showing up in Greece's bond yields, which have surged over 20% -- nearly triple the level six months ago. Bondholders don't like losses, so a Greek restructuring would scare off investors from holding the bonds of other weak euro zone economies, such as Spain and Italy, making other bailouts more likely. The second lesson is political. The chief culprit is Germany. All along, it has tried to have it every wayto back Greece, but to punish it for its mistakes; to support the Greek economy, but not to spend any money doing so; to treat this as just a Greek problem, when German banks and German citizens, who lend to Greece, stand to lose money too. German voters do not favour aiding Greece. But rather than explain to them why it is in Germanys interest, the chancellor, Angela Merkel, has run scared of upsetting them before a big regional election. The EU support packages by themselves cannot solve the problems that come with the budgetary imbalances. The programs can merely assist a government to finance the transition when it puts measures into place to rectify the situation in its effort to restore market confidence. In the end, however, the programs are a "Band-Aid", as they provide the window of opportunity to be kept open somewhat longer for the debtor governments to regain market access. However, just as with IMF programs, there is no certainty of success, the program targets may be missed and official disbursements discontinued. Therefore, while helpful in the transition, the financial support programs are not necessarily a guarantee that government debt couldn't face restructuring.

The political winds are blowing in the wrong direction for solving debt crises. The recent election in Finland spooked markets due to the stellar performance of the True Finns party. The nationalist True Finns are openly anti-euro and anti-bailout, and though it is unclear if they will be part of a new, coalition government, their success has generated worries that Finland will oppose future bailouts, such as the one currently being negotiated for Portugal. In the wacky world of euro zone politics, decisions have to be unanimous, so any one member, even one like Finland with a mere 5.3 million people, can thwart policy for the entire zone.

THE FUTURE With the eurozone shaken by debt crisis, the question is being raised: how did it happen. In retrospect, its clear that the fault was not in the terms of the European Union Treaty, the Treaty of Maastricht, itself but lack of political courage to supervise the implementation and reform flawed measures. Focus was on fiscal policy with well-known guidelines for deficits and debts. What wasnt foreseen was the anomaly of capital markets over the first 10 years. That weak countries could continue to borrow at interest rates determined by the strongest country Germany fuelling an irresponsible monetary policy escaped notice. The countries exploiting this opportunity cannot in any way be exonerated from guilt. But they were not the only ones missing the looming disaster. A large number of European banks, the rating agencies, and the cohort of primarily US and British economists and columnists now somewhat belatedly queuing to criticize the EU overlooked it. The financial markets delivered a prime illustration of overshooting: Warnings went ignored and lending continued even if the highly paid experts should have seen the writing on the wall. When it went wrong, the markets abruptly stopped lending thereby aggravating a crisis partly of their own making. The crisis is comparable to the 2007/2008 US financial crisis, highlighting an increasingly agonizing swing of corporate governance. Is it acceptable that financial institutions can pursue a course boosting profits from a purely

egotistic policy, ignoring an implicit contractual obligation to incorporate societal repercussions in their policies? Is it so that governments can neglect the effects of such policies, referring to free enterprise and the market? The answer: Yes, that is so, but the results in the form of a global recession, the US economy heading full speed into a debt trap, and severe difficulties for the euro gives rise to second thoughts.

This leads to one of the main questions placed squarely on the European agenda: burden sharing. Weak countries like Greece have acted irresponsibly, without doubt, but what about the banks allowing them to do so in their own quest for profits? How to distribute the burden among countries, taxpayers in debtor versus creditor countries, and the private sector, including banks inside debtor countries and creditor countries?

The future of the euro depends upon policymakers abilities to find economically workable and politically acceptable solutions to this problem. Until a couple of weeks ago, the fumbling and hesitation did not inspire confidence, irrespective of the fact that the euro was doing well it has risen vis--vis the US dollar over the last 12 months although that may say more about the dollars weakness than the euros strength. The eurozone took a decisive step at the July 21-22 meeting, trying to move ahead the curve by putting in place a respectable package designed to revive Greece and establish a fence around Ireland, Portugal, possibly Spain and Italy, asking the banks to write off a bit more than 20 percent of their claims low compared to other cases over the last 20 years beefing up the European Financial Stability Fund plus other measures to ensure the euros survival. First, the rating agencies have become a bit erratic. They were far too lenient prior to the global financial crisis, and now they adopt the opposite attitude, crying wolf at the slightest movement in the forest. Granted, time is needed to allow rating agencies evaluate policy measures and find their own feet after having been so wide off the mark, but too many players in the market seek short-term profits for themselves in forcing one or several member states into

default and possible breakup of the euro. A test of willpower between the euro-zone governments and the financial markets is playing out. The euro-zone will win this contest because its a question of survival while the markets can and will switch their search for profits to other victims, like the US and probably also the US states, many of which will be severely hit by spending cuts in the federal budget. The second test is success or failure of the weak countries to appear more solid and competitive over the next few years. The jury will be out for some time, but the answer seems positive provided the markets give these countries a chance. All have adopted and implemented serious austerity measures. Compared to the inactivity of the United States, the measures look gigantic. According to Goldman Sachs, the euro-zone budget balance in per cent of gross domestic product was -6 in 2010, estimated to fall to -4.4 in 2011 and further to -3.6 in 2012. Greece will go from -9.2 in 2010 to -5.6 in 2012. Italy and Spain anticipate a similar trajectory. The public generally seems willing to go along despite some protests. Indeed, widespread predictions of street riots and governments tumbling have not materialized. The reward is that economic growth in the euro-zone is neither falling nor flat. It is going up.

The third point is a revision of the terms in the 1993 Treaty of Maastricht. Not fundamental changes, but steps towards a stronger fiscal union not only in words, but in deeds to prevent a repeat of the challenges during the euros first decade. This will be accompanied by euro bonds, or bonds guaranteed by all euro-zone member states. Reading between the lines, the message is emerging from the leading countries that they recognize the need for revisions and are prepared to act accordingly, but as so often seen with the European integration, time is required, not just a snag of a year or two, but more during which political will be tested. The crisis will break or make the future of European integration. The overwhelming odds are that the current debt crisis will usher in a new phase of integration. The crisis has hammered home: No European country can survive alone. Without the euro, the global financial crisis would surely have led to a

currency war among the European countries with disastrous results for the global economy. Some people flirt with the idea of Germany leaving the euro, standing alone as a knight in shining armour with a strong currency, low inflation and fiscal responsibility. It was seen during the 1970s and 1980s that this cannot be done and was the prime motivation for the single currency. It would be odd if Germany left precisely when the eurozone slowly, steadily is coming round to adopt fiscal responsibility and low inflation, not because it is the German model, but because its been tested and viewed as best. Nor is it realistic to see other member states leave the euro, choosing to face economic and social meltdown brought along by failure to control fiscal imbalances and manage the economy. The markets would avoid such players. Their voices in other EU matters would carry little or no weight. There are no viable alternatives. If for no other reason then, the euro is here to stay.