The European Debt Crisis -- Visualized
What is the European Debt Crisis ?
It's the failure of the Euro.
The currency that ties together 17 European countries in an intimate but flawed manner.
Over the past three years,
Greece, Portugal, Ireland, Italy and Spain.
have all teetered on the brink of financial collapse
threatening to bring down the entire continent
and the rest of the world.
How did it happened ?
Uniting Europe
For most of Europe's history,
it's been a war with itself.
And countries at war with each other
tend to do less business together.
Europe ishas always been a continent of trade barriers, tariffs and different currencies.
Doing business across borders was difficult.
You needed to pay a fee to exchange currencies.
And you needed to pay a tariff fee to buy and sell to companies in other countries.
That tended to stifle economic growth.
Then came World War II,
which devastated Europe.
Because the situation was so dire,
the fastest way to rebuild Europe was to begin to remove these barriers.
Steel and coal tariffs came down
so that a steel mill in one country could sell to a builder in another.
This gave the survivors an idea.
A unified Europe, a union across the continent
that will end future wars.
Countries began to band together toward this goal,
bringing down trade barriers, lowering the cost of doing business.
One of the last barriers to fall was the Berlin Wall.
With the united Germany, Europe was ready.
27 countries signed the Maastricht Treaty
and created the European Union.
This made doing business across borders easier,
but there is one major obstacle: the different currencies.
A decade later, they had one.
The Euro, launched on January 1,1999.
Countries adopting the euro, called the euro area,
discontinued their own currencies.
They also discontinued their own monetary policies,
giving control to newly formed European Central Bank,
commonly referred to as the ECB.
The euro area now have one unified monetary policy,
but it still have many different fiscal policies,
a key reason for the current debt crisis.
Monetary policy versus Fiscal policy
You see it's important to understand the difference between
monetary policy and fiscal policy.
Monetary policy controls the money supply,
literally how much money there is in the economy,
and what the interest are for borrowing money.
Fiscal policy controls how much money a government collects in taxes,
and how much it spends.
A government can only spend as much as it collects in taxes.
Anything above that amount it has to borrow.
This is called "Deficit Spending".
Before the euro,
countries like Greece, not only had to pay high interest rates to borrow,
but they can only borrow so much.
Lenders weren't comfortable lending them to much money.
But now that they were part of the euro area new united monetary policy,
the amount they can borrow skyrocketed.
Smaller countries suddenly have access to credit like never before.
Greece and other countries
which previously could only borrowed at rates around 18%,
could now borrow for the same low rate as Germany.
How?
Germany's credit card.
You see, joining the euro area
is a lot like sharing a credit card, Germany's credit card.
Lenders now believe that if Greece was unable to repay its loans,
Germany and the other bigger economies of Europe
will stepped in and repay them.
Because they were now bond by a common currency.
With the new abundance of cheap credit,
Greece and other European countries were able to adjust their fiscal policies,
and increase spending to previously impossible levels.
Some countries embarked on huge deficit spending programs,
primarily for politicians to get elected.
They made promises such as more jobs and generous pensions,
all that paid for with the new money they could now borrow.
The government of Greece, Portugal, and Italy accumulated huge debt,
however, they were able to repay these debts with more borrowed money.
As long as the borrowing continued, so did the spending,
and the unbalanced fiscal policies.
In Ireland and Spain, cheap credit fueled enormous housing bubbles
just as it did in the United States.
Credit flowed, debt accumulated, and the economies in Europe became tightly intertwined.
Companies began opening factories and offices across Europe.
German banks lending to French companies, French banks lending to Spanish companies
and so on and so forth. This made doing business incredibly efficient,
while at the same time tying together the collective fate of the Euro area.
Things continue this way as long as credit was available and credit was available
until 2008.
Spurred by a collapse in the US housing market,
a credit crisis swept the globe bringing borrowing to a halt. Everywhere.
Suddenly the Greek economy couldn't function.
It couldn't borrow money to pay for all the new jobs and benefits it created.
It couldn't borrow the new money it needed to pay its all debts.
This was a problem for Greece
but because of the unified monetary policy,
it was also a problem for all of Europe
Much of Europe have been on a spending spree
and borrowed more money than it could ever repay.
but the problem is somebody has to pick up the tab
or else every country in the euro area will suffer.
Since the countries that ran up the bill couldn't repay
everyone looked to Germany.
Austerity Measures
As the biggest and strongest economy in Europe
Germany reluctantly agreed to help bail out the debtor countries.
In other words, Germany agreed to repay the bill
but only if the debtor countries agreed to implement strict austerity measures
to ensure that it would never happen again.
Austerity measures meant sucking it up,
cutting spending, borrowing less and paying back more debt.
This sounds like a simple solution, right? It's not.
First of all, nobody wants austerity.
Austerity means cutting government spending
and since the government is by far the biggest spender in the economy
when the government cut spending, it cuts the earnings of many of its citizens.
People lose jobs, they get angry, they riot in the streets.
And austerity also doesn't automatically balance a country's budget.
You see, the government collects taxes based on people's earnings.
So when earnings are reduced, the government collects lesser taxes.
They still can't pay down their debts.
The pain is so bad that it's almost politically impossible to accomplish.
On top of that there are huge cultural differences within the Euro area.
Extreme Cultural Differences
Germany is very financially responsible.
Ever since the terrible hyper-inflation the country experienced after World War I
it's been extremely inflation averse
and incredibly careful about spending and borrowing.
In general, Germans work hard,
expect little in the line of state benefits
and meticulously pay all of their taxes.
Many Greeks, on the other hand, enjoy generous state benefits and don't pay taxes.
Greece has a terrible problem, it has never collected the majority of the taxes it imposes on its citizens
and its always been this way.
Joining the Euro just amplified it.
The German view is that doesn't work.
If you want our money, you need our morals.
As the debtor countries headed towards default
the whole continent of Europe was in danger.
Even though the economies of the debtor countries are relatively small,
they posed a huge threat
because the European financial system is so interconnected precisely because of the Euro
Remember, the debtor countries borrowed money from banks, investors, and other governments throughout Europe,
as the debtor countries get closer to default
everyone who lent them money becomes weaker
and everyone who lent those lenders money also becomes weaker,
and so on and so forth.
A problem in one country could reverberate across the whole continent,
triggering a chain-reaction of default.
If Greece defaults then Spain could default,
Italy, Portugal, and Ireland would be next,
then France, then Germany
pretty soon it could spread not just across Europe but across the world.
Fiscal Union or Breakup
The problem is even if the debtor nations adopt austerity measures
and even if the bailout from Germany in the stronger countries helps them pay down their debts and avoid the immediate crisis
There's no system in place to prevent this from happening again.
This brings us back to that fundamental division of monetary policy and fiscal policy.
Ultimately, the euro area requires a fiscal union to match its monetary union,
or neither.
That is, there must be a political organization with authority to set fiscal policy within every Euro area country.
It must have the power to cut spending, raise taxes and set laws.
A fiscal union like this could actually prevent excessive borrowing and spending.
However, this is an enormously complicated and unpopular notion.
It means surrendering sovereignty to a higher power,
in essence, a United States of Europe
Yet without a centralized fiscal union
countries will continue to run deficits, accumulate debt,
degrade the value of the Euro and threatens stability in Europe.
Can Europe take the necessary steps and create a fiscal union alongside the monetary union?
Or will the monetary union breakup and the Euro disappear?