The European Debt Crisis
By Caroline Margiotta
Since 2008, the European Debt Crisis has remained at the forefront of international public policy concerns. As the economies of Europe and the United States hover on the precipice of stagnation and recession, world leaders are frantically attempting to reduce debts and restore growth in any way they can. Though most avid news-readers consider themselves fairly well-informed on the crisis, its causes go beyond the accumulation of debt in Portugal, Italy, Greece, and Spain, and it will affect many countries in Europe and around the world. Moreover, it has inspired and will continue to inspire highly varied public policy solutions, as well as many conflicts.
While many Americans believe that the European Debt Crisis only recently originated in Europe and will remain a strictly European issue, the crisis is neither new nor isolated to Europe. Rather, it results from irresponsibility on the part of both European governments and United States banks and other lenders. The crisis’s origins on the European front can be traced to 1997, when Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia, Spain, Cyprus, Malta, and Slovakia—countries linked together by their common currency, the Euro, as well as by their membership in the European Economic Community (EEC)— signed the Stability and Growth Pact . In signing this pact, European leaders hoped to establish a borrowing limit of 3 percent of a country’s nominal GDP to encourage each country’s government to spend its funds wisely and within its means. However, Germany, Italy, France, Greece, and Spain have not upheld the 3 percent borrowing rule. Although Germany and France are considered the most fiscally stable countries in Western Europe, they were among the first to break the rule, and were soon followed by Italy (the worst and most regular offender). Greece followed sometime shortly thereafter but its breach of the limit went largely unnoticed until Prime Minister George Papandreou revealed that the Greek government had been manipulating its borrowing data in an effort to escape the notice of European Central Bank (ECB) watchdogs. In 2007, when Spain broke the borrowing limit for the first time, the EEC’s concerns lay only with these countries’ open disobedience of the Pact. Because of abnormally low interest rates, Spanish corporations and mortgage borrowers joined their Italian counterparts in borrowing massive amounts of money from foreign lenders. With this extra money, Portuguese, Italians, Greeks, and Spaniards were able to import more German goods; this created massive profits for Germans, who soon extended loans to the same Portuguese, Italians, Greeks, and Spaniards (PIGS) who imported their goods. As a result of these loans, PIGS firms and borrowers have been forced to reallocate their funds towards the repayment of their massive debts, which has led to a significant decrease in spending and recessions in each country.
The portion of the financial crisis which began in the United States, meanwhile, took a fairly different turn, and had immediately far-reaching consequences. It began in 2006, when relators began to give out and resell large subprime loans as part of mortgage-backed securities to hedge funds and other financial institutions around the world. Because these mortgages were divided into many different types of assets, their derivatives were nearly impossible to price, so their value plummeted . After AIG failed honor the credit default swaps it sold, banks stopped lending to each other, so borrowing costs between banks increased. Although this subprime mortgage crisis led the Fed to initiate a round of quantitative easing (QE1) in 2008 to increase liquidity in the economy, several banks, such as Bear Stearns and Lehman Brothers, began failing because they held too many devalued assets, and the Treasury was forced to bail out Fannie Mae and Freddie Mac (mortgage corporations) as well as AIG3. The subprime mortgage crisis created slow growth in economies throughout the world, and thus exacerbated the debt issues developing simultaneously in Europe.
As a result of slow growth throughout the global economy, it has become increasingly more difficult for European countries to fulfill their debt obligations. In Greece, for example, continuously massive spending, lower tax revenues (which have resulted from slower growth), and investors’ continued demands that Greece pay a higher yield on its bonds have prevented the government from paying off its growing debt . Since the rest of the PIGS have similar debt issues, the European Union (EU) and International Monetary Fund (IMF) have cooperated in providing bailouts to the countries’ banks in an effort to lessen their debt burdens. While the bailouts have temporarily diminished the PIGS’s debt issues, they have often required the IMF to issue a set of “follow-up” bailouts, as Greece did in 2011 after it was given $163 billion in Spring 20104. Because the size of the debt has not decreased, furthermore, the European Central Bank has stepped in to (i) purchase bonds to reduce interest rates and decrease the price of yields, (ii) provide billions of Euros in credit to troubled banks via a Long Term Refinancing Operation, and (iii) increase bank balances to encourage loan growth (and therefore economic growth)4. Of course, because the EU, the ECB, and the IMF must focus on simultaneously aiding four large countries and advising their governments on means of preventing such issues in the future, it has become and will become increasingly difficult for them to put an end to the debt crisis.
Although, in America, we might believe that the European Debt Crisis cannot affect us, the crisis has already had a massive impact on our economy and our world. In the financial market, for example, European bank stocks have performed very poorly, and rising yields have led to higher bond prices. If Americans were to buy bonds from one of the PIGS, and if the country could not honor its debt obligations, a bond purchaser would lose money as the bond price fell below face value. The crisis also affects our entire economy because, since about 40 percent of the IMF’s capital comes from the US, US taxpayers might have to pay if the IMF gives out too much money in bailouts. Finally, the crisis affects global politics because it has enabled far-left and far-right parties, such as the French Socialist Party, to gain power; because many Americans oppose these parties’ extreme political positions, European politics has become a point of fear for many of our citizens. Above all, however, the European debt crisis can teach our government and our citizens an important lesson about the hazards associated with borrowing outside one’s means, and can cause us to rethink our borrowing habits.
Because the European Debt Crisis can adversely affect our economy and may forever change European politics and global trade, it has become a major concern of the American public and the US Government. The American public has perhaps taken greater interest in the fate of the PIGS, as it believes that the crisis could affect taxation as well as the national debt. According to Rasmussen Reports, as of November 2011, roughly 64 percent of Americans believed that at least one of the PIGS would default on its debt within the next 5 years, and as of May 2012, 61 percent of Americans believed that European leaders should cut spending to improve the economy . These Rasmussen polls illustrate that the majority of Americans followers of international news recognize the gravity of the European Debt Crisis as well as the ties between the European and American economies, and see that our country’s spending habits, which are unsettlingly similar to those of many European countries prior to the debt crisis, are unsustainable. In fact, as of December 2011, 76 percent of Americans said that they believed that the size of our national debt, which somewhat echoes the size of the debts of the PIGS, presents the greatest threat to our economy.
American politicians have similarly expressed great concern over the growing European debt. Mitt Romney and Barack Obama, for example, have come into conflict over what, if anything, they believe should be done about the Debt Crisis. President Obama has commendably recognized the dangers of allowing Europe to fall, as, “if there’s less demand for our products in places like Paris or Madrid it could mean less business for manufacturers in places like Pittsburgh or Milwaukee” . Though he recognizes that the United States can only give advice to the European Union, Barack Obama has also repeatedly spoken out against rapid-fire austerity, as it would drastically shrink government, hurting job growth and the middle class, and would make it more difficult for the PIGS to pay off their debts . He also recommends that European leaders inject capital into weak banks banking system to keep Greece in the Eurozone and to stabilize Europe’s financial system . This, President Obama alleges, would team with his domestic jobs bill to strengthen the US economy11. Republican Presidential Candidate Mitt Romney, in contrast, has stated that President Obama’s policies and spending will lead us into a situation similar to that of Europe9. He does not recommend that we help to bail out Italy, or that we become any more involved than we currently are; rather, he wants Europe to take care of the Euro itself . Like most Republicans, Mitt Romney has not taken a strong official stance on the Europe bailout, but does not believe that the US should be involved in European affairs (aside from giving occasional advice); he believes that we should, instead, focus on repairing our own deeply-flawed economy.
While both the Republicans and the Democrats’ stances have their flaws, there is some merit in each side’s plan to pull the United States through the European Debt Crisis. Although President Obama and the Democrats are correct to recognize that the collapse of European economies will adversely affect our exports, it is neither our place to advise or prod European leaders to carry out certain fiscal policies. Accordingly, we should not, by any means, contribute any money towards the bailouts of European banks. First of all, it is not our place to give money to the PIIGS because we have not been asked to fund the bailouts, and because these are not our banks to manage. Additionally, contributing funds to European bank bailouts would likely increase the US government’s already excessively-high budget deficit, would probably exacerbate Europe’s debt issues, and would distract our federal government from dealing with more pertinent domestic issues, such as the unemployment rate and national debt.
If we are to maintain strong relationships with each country in the European Union, and if we expect to repair and stabilize the global economy, we must let European leaders know that, should they want advice from the United States, we would be happy to try to advise them. However, we should remember that the US economy is not perfect, either. As French Foreign Minister Laurent Fabius stated on June 5th, “the [European debt] crisis did not start in Europe… [It began with the collapse of Lehman Brothers, which was [an American, rather than] a European bank” . Since Lehman Brothers did play a significant role in exacerbating the debt crisis, because our debt has exceeded 101.5 percent of our GDP since May, and because the true unemployment rate, which includes discouraged workers, has hovered around 15.6 percent for several years, according the American Enterprise Institute, Monsieur Fabius was correct in reminding world leaders that “we’re all in the same boat” 13. As Mitt Romney and the Republicans have stated time and again, and as French Foreign Minister Laurent Fabius has agreed, it would neither be wise nor appropriate for the United States to help the European Union fix its debt issues. Thus, Mitt Romney (R-MA)’s non-interventionist approach to the Eurozone crisis holds far more promise for the future of Euro-American relations and global economies than President Obama’s fundamentally interventionist approach. Although the American public as a whole may not approve of such a non-interventionist approach, given the severity of Southern European recessions, the United States must focus primarily on repairing its own economy before venturing to intervene in other economies.
In sum, given the importance of international trade and the interconnectedness of global economies, the European Debt Crisis has understandably gained prominence and will certainly remain prominent in discussions of global fiscal policy until the United States and the European Union can manage to drastically cut their debts, balance their budgets, and restore growth to their economies. Because the debt crisis arose because of foolish actions by American banks and European governments, and because the crisis will significantly affect American business if allowed to run its course, both the American public and American politicians believe that dangerous economic situation in Europe cannot be allowed to continue without some intervention, either on the part of the United States or on the part of more prosperous European nations. While both Democrats and Republicans recognize that the United States cannot feasibly intervene with legislation or by giving additional funds to European banks, Democrats feel that the United States should take a more active, advisory role than do Republicans. In any case, whether or not Americans believe we should intervene in Europe’s recovery, we all must recognize that the future of our global economy depends largely on the fate of Europe.
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15 Prasad, Bhaskar. “Real U.S. Unemployment Rate Is 15.6 Percent, Says AEI.”International Business Times. International Business Times, 7 Jan. 2012. Web. 10 June 2012. http://www.ibtimes.com/articles/278036/20120107/real-u-s-unemployment-rate-15-6.htm .
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