Thursday, December 1, 2011

Severing Symbiosis Causes EU Debt Crisis to Escalate

The European debt crisis has set to hit new heights. Greece is now the first developed economy to force-restructure its sovereign-debt since World War II. According to current plans, private-sector investors will suffer 50% losses. Yet the double consequences are far and wide. First the symbiotic relationship between banks and governments has been mangled. Second the inhomogeneous Euro area will prevent Greece from recovering in time to avoid a total crisis.

When a country is in debt, banks provide the money, the government spends it and, in return, guarantees future payments. This trust was broken when Managing Director Charles Dallara of the Institute of International Finance was summoned into the 14th summit since Europe pledged solidarity with Greece, to accept and deliver an order to banks to "volunteer" 50 percent write-downs on Greek debt. In other words, if private investors lent the Greeks money by buying their government's bonds, they must volunteer to forfeit half of it.

EU leaders walked out of the meeting and were proud of the bailout solution. But, when the bailout for Greece fell unequally heavy on banks, Italy and Spain came under pressure, not because their finances had suddenly deteriorated, but because investors lost their government guarantees. Ten days after the EU resolution for Greece, growing investor panic over indebted Italy's ability to pass austerity measures and pay its bills, sent the world's eighth-largest economy's borrowing rate soaring and forced Italy's Prime Minister Silvio Berlusconi to resign.

With damaged trust, Euro leaders will face stiff resistance from investors and countries such as China to partner in future rescues.

The Euro zone is not homogenous and this is the second problem. Different countries have different cultural preferences, political priorities and economic issues. A comparison with the US can point out the difficulty. During the Civil War, a total of three currencies circulated in the US - the Confederate dollar, the Union's "greenback" and the gold backed dollar. Today there is only one currency. Like Europe, each state has its own cultural, political and economic priorities, but the USA is still one country. A bankrupt family in California can pack up and drive to Washington D.C. in one night to find employment. Such mobility between countries do not exist in the Euro zone.

The Greek government has pursued an aggressively stimulative policy in pursuit of economic growth. However the country has suffered the depreciation of the Turkish lira against the Euro. Greece is also overly dependent on tourism and has set an unsupportable standard of living of its citizens. The country is insolvent and it will not be able to return to financial markets for financing and the prospect it can significantly reduce its debt is not encouraging.

Copyright: By Paula Summerwind and David Polint. This work is licensed under a Creative Commons Attribution 3.0 Unported License. You are free to distribute, remix, tweak and build upon this work as long credit is given to and a link is above or below the article.

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