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The European Debt Crisis -- Visualized

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What is the European Debt Crisis ?

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It's the failure of the Euro.

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The currency that ties together 17 European countries in an intimate but flawed manner.

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Over the past three years,

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Greece, Portugal, 
Ireland, Italy and Spain.

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have all teetered on the brink of
financial collapse

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threatening to bring down the entire continent

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and the rest of the world.

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How did it happened ?

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Uniting Europe

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For most of Europe's history,

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it's been a war with itself.

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And countries at war with each other

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tend to do less business together.

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Europe ishas always been a continent of trade barriers,
tariffs and different currencies.

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Doing business across borders
was difficult.

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You needed to pay a fee
to exchange currencies.

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And you needed to pay a tariff fee
to buy and sell to companies in other countries.

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That tended to stifle economic growth.

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Then came World War II,

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which devastated Europe.

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Because the situation was so dire,

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the fastest way to rebuild Europe
was to begin to remove these barriers.

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Steel and coal tariffs came down

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so that a steel mill in one country
could sell to a builder in another.

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This gave the survivors an idea.

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A unified Europe,
a union across the continent

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that will end future wars.

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Countries began to band together
toward this goal,

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bringing down trade barriers,
lowering the cost of doing business.

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One of the last barriers to fall
was the Berlin Wall.

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With the united Germany, Europe was ready.

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27 countries signed the Maastricht Treaty

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and created the European Union.

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This made doing business
across borders easier,

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but there is one major obstacle:
the different currencies.

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A decade later, they had one.

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The Euro, launched on January 1,1999.

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Countries adopting the euro,
called the euro area,

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discontinued their own currencies.

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They also discontinued
their own monetary policies,

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giving control to newly formed
European Central Bank,

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commonly referred to as the ECB.

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The euro area now have
one unified monetary policy,

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but it still have many
different fiscal policies,

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a key reason for the current debt crisis.

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Monetary policy versus Fiscal policy

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You see it's important to understand
the difference between

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monetary policy and fiscal policy.

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Monetary policy controls the money supply,

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literally how much money there is
in the economy,

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and what the interest are
for borrowing money.

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Fiscal policy controls how much money
a government collects in taxes,

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and how much it spends.

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A government can only spend
as much as it collects in taxes.

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Anything above that amount
it has to borrow.

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This is called "Deficit Spending".

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Before the euro,

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countries like Greece, not only had to
pay high interest rates to borrow,

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but they can only borrow so much.

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Lenders weren't comfortable
lending them to much money.

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But now that they were part of
the euro area new united monetary policy,

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the amount they can borrow skyrocketed.

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Smaller countries suddenly
have access to credit like never before.

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Greece and other countries

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which previously could only borrowed
at rates around 18%,

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could now borrow for
the same low rate as Germany.

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How?

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Germany's credit card.

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You see, joining the euro area

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is a lot like sharing a credit card,
Germany's credit card.

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Lenders now believe that if Greece
was unable to repay its loans,

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Germany and the other 
bigger economies of Europe

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will stepped in and repay them.

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Because they were now bond by
a common currency.

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With the new abundance of cheap credit,

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Greece and other European countries
were able to adjust their fiscal policies,

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and increase spending
to previously impossible levels.

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Some countries embarked on
huge deficit spending programs,

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primarily for politicians to get elected.

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They made promises such as
more jobs and generous pensions,

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all that paid for with the new money
they could now borrow.

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The government of Greece, Portugal,
and Italy accumulated huge debt,

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however, they were able to repay
these debts with more borrowed money.

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As long as the borrowing continued,
so did the spending,

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and the unbalanced fiscal policies.

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In Ireland and Spain, cheap credit fueled
enormous housing bubbles

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just as it did in the United States.

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Credit flowed, debt accumulated,
and the economies in Europe became tightly intertwined.

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Companies began opening factories
and offices across Europe.

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German banks lending to French companies,
French banks lending to Spanish companies

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and so on and so forth. This made
doing business incredibly efficient,

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while at the same time tying together
the collective fate of the Euro area.

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Things continue this way as long as
credit was available and credit was available

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until 2008.

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Spurred by a collapse
in the US housing market,

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a credit crisis swept the globe
bringing borrowing to a halt. Everywhere.

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Suddenly the Greek economy
couldn't function.

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It couldn't borrow money to pay for
all the new jobs and benefits it created.

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It couldn't borrow the new money it needed
to pay its all debts.

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This was a problem for Greece

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but because of the unified
monetary policy,

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it was also a problem for all of Europe

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Much of Europe have been on
a spending spree

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and borrowed more money
than it could ever repay.

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but the problem is
somebody has to pick up the tab

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or else every country
in the euro area will suffer.

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Since the countries that
ran up the bill couldn't repay

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everyone looked to Germany.

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Austerity Measures

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As the biggest and strongest economy
in Europe

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Germany reluctantly agreed
to help bail out the debtor countries.

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In other words,
Germany agreed to repay the bill

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but only if the debtor countries agreed
to implement strict austerity measures

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to ensure that
it would never happen again.

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Austerity measures meant sucking it up,

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cutting spending, borrowing less
and paying back more debt.

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This sounds like a simple solution, right?
It's not.

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First of all, nobody wants austerity.

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Austerity means
cutting government spending

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and since the government is by far
the biggest spender in the economy

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when the government cut spending, it cuts
the earnings of many of its citizens.

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People lose jobs, they get angry,
they riot in the streets.

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And austerity also doesn't automatically
balance a country's budget.

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You see, the government collects taxes
based on people's earnings.

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So when earnings are reduced,
the government collects lesser taxes.

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They still can't pay down their debts.

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The pain is so bad that it's almost
politically impossible to accomplish.

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On top of that there are huge cultural
differences within the Euro area.

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Extreme Cultural Differences

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Germany is very financially responsible.

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Ever since the terrible hyper-inflation
the country experienced after World War I

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it's been extremely inflation averse

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and incredibly careful about
spending and borrowing.

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In general, Germans work hard,

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expect little
in the line of state benefits

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and meticulously pay all of their taxes.

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Many Greeks, on the other hand,
enjoy generous state benefits and don't pay taxes.

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Greece has a terrible problem, it has never collected
the majority of the taxes it imposes on its citizens

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and its always been this way.

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Joining the Euro just amplified it.

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The German view is that doesn't work.

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If you want our money,
you need our morals.

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As the debtor countries
headed towards default

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the whole continent of Europe
was in danger.

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Even though the economies of
the debtor countries are relatively small,

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they posed a huge threat

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because the European financial system
is so interconnected precisely because of the Euro

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Remember, the debtor countries borrowed money from banks, investors, and other governments throughout Europe,

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as the debtor countries
get closer to default

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everyone who lent them money
becomes weaker

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and everyone who lent those lenders money
also becomes weaker,

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and so on and so forth.

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A problem in one country could reverberate
across the whole continent,

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triggering a chain-reaction of default.

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If Greece defaults
then Spain could default,

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Italy, Portugal,
and Ireland would be next,

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then France, then Germany

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pretty soon it could spread not just
across Europe but across the world.

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Fiscal Union or Breakup

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The problem is even if the debtor nations
adopt austerity measures

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and even if the bailout from Germany in the stronger countries helps them pay down their debts and avoid the immediate crisis

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There's no system in place
to prevent this from happening again.

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This brings us back to that fundamental division
of monetary policy and fiscal policy.

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Ultimately, the euro area requires a
fiscal union to match its monetary union,

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or neither.

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That is, there must be a political organization with authority to set fiscal policy within every Euro area country.

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It must have the power to cut spending,
raise taxes and set laws.

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A fiscal union like this could actually
prevent excessive borrowing and spending.

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However, this is an enormously complicated
and unpopular notion.

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It means surrendering sovereignty
to a higher power,

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in essence, a United States of Europe

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Yet without a centralized fiscal union

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countries will continue to
run deficits, accumulate debt,

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degrade the value of the Euro
and threatens stability in Europe.

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Can Europe take the necessary steps and create a fiscal union alongside the monetary union?

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Or will the monetary union breakup and
the Euro disappear?