The Genesis of the Crisis in Eurozone and its Repercussions for the Global Economy

The Eurozone Disaster: Monetary Union without Fiscal Union

Any student of political science and economics would tell you that unless there is a combination of the power to issue currency and at the same time levy taxes and impose fiscal rules, there could not be an arrangement where we have one without the other. In other words, if a country can only issue currency but not have fiscal powers, then that country would be in a cesspool where it is held together by accident rather than by design. This is precisely the case with the Eurozone where there is a common currency but each member country makes its own fiscal policies. For instance, the European Union has the Euro as the common currency and each country has its own set of fiscal policies. This leads to a situation where the weaker countries in terms of exports and revenues have to be supported by the stronger countries that have favorable trade balances and have better revenues. This is what is happening in the Eurozone ever since the sovereign debt crisis broke out in 2010. For instance, Greece is a country that is heavily indebted and has negative trade balance. To keep itself afloat, it has to borrow from the ECB or the European Central Bank that is supported by other EU countries. This leads to a scenario where the EU can bail out member countries but not set prudent fiscal policies to be followed. Though the ECB makes it mandatory for member countries receiving bailouts to adhere to the strict conditions set by it, there is lot of resentment and protest against these rules by the citizenry because they see this as interference and intervention into their lives. This is the genesis of the Eurozone crisis where each country shares the currency but has different fiscal rules related to taxation and budgets.

Repercussions for the Global Economy

The repercussion for the global economy from the Eurozone crisis are that many developed and developing countries and their central banks hold a lot of debt that has been issued by the EU countries. This means that in the likelihood of default from these EU countries, these holders of debt stand to lose a lot of money. Added to that are the derivatives that are traded on the top of the normal bonds and other instruments, which means that a default by say, Greece, threatens the stability of the entire global economy. This was precisely what happened in March 2012 when Greece almost defaulted on its debt. In order to prevent the global economy from taking a hit, the ECB and the lenders to Greece hit upon the solution that the creditors of Greece have to take a hit in their holdings or what is known in financial jargon as a “haircut” for the creditors. This resulted in many banks across the world writing down the values of Greek debt and this includes Cyprus where its banks that were large holders of Greek debt had to suffer losses. This resulted in Cyprus itself needing a bailout in the last month or so. However, by this time the ECB had wizened up and insisted that the depositors in the Cyprus banks be made to part with their savings to finance the bailout or as it is now called, bail-in. In the annals of finance, this is unprecedented as this is akin to asking ordinary investors and savers to forego their deposits and cash because the bank had made terrible financial decisions.

Closing Thoughts

Finally, the Eurozone crisis has other dimensions as well and these include the democratic deficit of the EU and the fact that most of the peripheral countries lived beyond their means whereas the core countries were better off in financial management. Of course, in recent weeks, news has emerged that even these core countries are experiencing economic crises and hence, there is no guarantee that they would continue to bailout the weaker countries. We shall be exploring some of these topics in subsequent articles.

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