Financial Turmoil in Europe

May 14

Failing to follow good practices always keeps us at risk and the same happened with European countries. According to The Financial Times, global investors have lost $6.3 trillion worth wealth in 2011 alone due to the Euro zone breakup. The European Union (EU) members signed the       Maastricht treaty in 1992, under which the members assured to control their deficit spending and limit their total borrowing to 3% of their economies.

According to rule the countries have to make sure that they are not accumulating too much debt and be free from financial crises. Everything was fine for almost a decade and with the Euro pact all countries could borrow money at the same interest rates from banks. With regulators allowing banks to buy government bonds, commercial banks were at the front to buy unlimited number of bonds to gain few extra basis points and bought bonds from weaker European countries. Now some of the European countries like Germany and France gained from the Euro zone, by keeping their debt at permissible level with high output. While at the same time countries like Portugal, Ireland, Italy, Greece and Spain (PIIGS) started spending too much to an extent where the debt of these countries crossed the size of their economy. With real estate crash and unemployment increase the burdens of these countries have piled up to such an extent that they needed bailout from the countries and banks.

Italy’s debt was 121% the size of its economy and for Ireland it was 109% and for Greece it stood at 165%. However the reason was different for different countries. Italy, which was doing well before 2000, saw a dramatic slowdown in its GDP and plunged to negative growth rates during 2008. As a result the country came up with new economic policy to balance the budget. On the other hand Portugal had more private debt than public debt and its economy has been shrinking like Italy and unemployment stood at 13%.

Ireland faced a massive real estate crash and banks faced a huge loss and finally the government came for rescue. Spain with 22% unemployment also faced the housing bubble and ended up with huge deficits due to lack of taxes collections to cover its revenues. Greece on the other hand borrowed too much and spent too much and creatively maintained its book keeping by hiding the fact from the euro zone authorities. Once the financial markets discovered that some European countries were in a position to repay their debts, they demanded higher interest rates from the commercial banks who have bought the bonds.

A sovereign debt crisis and banking crisis are the two main interlinked problems at the core of European crisis. European countries that shared the common Euro currency are a bunch of countries with vast differences in economies. The effect of these countries, which had huge debts not only fell on other European countries but also affected other financially strong countries like the United States. If there is a breakup in Euro zone, countries have to restore their previous currencies, which would have a low value against the Euro and would also be a nightmare leading to the financial collapse of the departing countries. American banks and US business owners who have interests in European banks and businesses can face credit crunch and can suffer huge losses incase Europe slips into recession as exports to these countries have already seen a downfall. Euro zone countries are doing their best to soothe the investors by cutting on the government spending and taking considerable steps in right directions to restore the system in their countries.

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