The European Debt Crisis Visualized

Feb. 12 (Bloomberg) -- At the heart of the European debt crisis is the euro, the currency that tied together 17 countries in an intimate manner at the time of the crisis. So when one country teeters on the brink of financial collapse, the entire continent is at risk. How did such a flawed system come to be? Bloomberg Television and Jonathan Jarvis present "The European Debt Crisis Visualized." (Source: Bloomberg)

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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?