Tightening of the European Union

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While the economic crisis currently unfolding in Europe could have proved enough to tear the European Union apart, it may become a catalyst of closer ties. European leaders have announced that they are seeking to further their commitment to each other by becoming more closely tied economically.

These leaders, such as German Chancellor Angela Merkel and French President Nicolas Sarkozy, want to create “a true European economic government” made up of European heads of state and headed by the president of the European Union. They would also seek to have the 17 countries incorporate a balanced budget into their constitutions.

The move hearkens back to the origins of the European Union, which started with the European Coal and Steel Community, which linked the steel and coal industries (industries which were fundamental to war materials production) in France, Germany, Belgium, Italy, Luxembourg, and the Netherlands. This union slowly morphed into the European Economic Community, which eventually gave way to the European Union.

The Problem with the Euro

The Euro may have seemed like a great idea when it was first put into circulation in 2002. However, it may be the source of the current problems in Greece, as well as Ireland, Portugal and Spain. The Euro is used by Austria, Belgium, Cypress, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, Spain, Montenegro, Andorra, Monaco, San Marino, Kosovo and the Vatican. It is estimated that 332 million people use the Euro every day with a further 150 million using currencies pegged on the Euro (mostly in Africa).

When it was implemented, the reasoning behind a single currency seemed admirable, noble even. Having one currency would simplify trade and travel between the many countries of Europe. People would not have to worry about the exchange rate when dealing with many countries and tourists would have an easier time getting around (and spending their money). It would make money more transient across Europe and encourage imports and exports. And it would do away with ridiculously inflated currencies. This is also an effort on Europe’s part to remain dominant in the world. By combining their economic weight in one currency Europe hopes to regain its previous place on the world stage.

When joining the currency union countries had to meet very strict economic guidelines, such as having a budget deficit of less than 3% of GDP, having a national debt of less than 60% of GDP, low inflation, and interest rates close to the European average. However, once in the union there were no longer rules to follow.

The problem with the Euro, as will be the case with any effort to institute a homogeneous currency over a heterogeneous area is that it is impossible for one to apply the same rules to different economies and expect similar results. Countries within the Euro zone grow at different rates. However, with a single currency there is only one set interest rate across the whole area. When growth is strong a country should have low interest rates so as to encourage more investment and spending, and because it is less likely that a default will occur on a loan. When an economy is weak or sluggish interest rates rise because it is more likely that a default will occur. It also takes away a country’s ability to affect interest rates or the money supply because they are no longer in control of either of these things.

What has happened in the European currency zone is that the growth of some countries like Germany and France has buoyed the interest rates and kept them lower in countries that would have otherwise had higher rates. This allowed more borrowing at less expense. It also allowed more borrowing then certain economies could handle effectively. This allowed the Greek, Spanish, Portuguese and Irish governments to increase their deficit spending without adversely affecting the interest rates in their countries.

Once strong economies like Germany stop allowing themselves to be tied down to weaker economies like Greece the Euro currency union will start to decline and ultimately break apart. Germany gains nothing by being linked to the likes of Greece, and the sooner they realize it they sooner Europe will stabilize their economies.

Greece’s Sovereign Debt Rating Downgraded to CCC

Standard & Poor’s has downgraded the Greek economy to a rating of CCC from B, the lowest possible. They believe that there will likely be one or defaults on the failing country’s national loans. “Risks for the implementation of Greece’s EU/IMF borrowing program are rising, given Greece’s increased financing needs and ongoing internal political disagreements surrounding the policy conditions required,” said S&P in a statement.

No other sovereign nation has as low a rating as Greece does, and only Ecuador has a worse rating. This comes after Obama has pressed Germany to structure a new bailout for Greece. It is possible that the economy could be downgraded to an ‘SD’, or selective default, if Greece has to take on a debt restructuring or a maturity extension on terms that constitutes a distressed debt exchange. This whole issue has arisen because of a failure of the Greek government to accurately portray the national debt and a slow as a result of economic recession.

S&P has said they would rather have Greece refinance their debt than using a bond swap or extended maturity on bonds as a method of debt management. The outlook is also negative, with the distinct possibility that there will be another downgrade coming in the next 12 to 18 months. Greece has made statements to the effect that they feel that S&P has overlooked all of the EU/IMF deliberations that are currently going on to figure out a way out of the intense clusterfuck of the Greek economic crisis.

Read more about Greece’s economic troubles here.

Obama Pushes for New Greek Bailout

President Obama has pressed the EU to consider a second bail out for the Greek economy and has pledged his country’s help in saving Greece from defaulting on its’ initial bailout. He is concerned that a repeated crisis in the Euro zone would indicate the same for the United States.

Obama met with Angela Merkel and talked about the importance of Germany’s leadership in shoring up and growing the Greek economy. “Other countries in the euro zone are going to have to provide them a backstop and support,” he said.” And frankly, people who are holding Greek debt are going to have to make some decisions, working with the European countries in the euro zone, about how that debt is managed.”
Merkel will have to walk a fine line in coming months as she balances pressure from within Germany to avoid becoming the financial savior of Europe with the pressure from other countries to do exactly that. A preliminary proposal is in the works to give between 80 and 100 billion Euros of aid to Greece.

Greece first accepted a 100 billion Euro loan to cover its debts in April 2010 from the EU and 40 billion Euros from the IMF bailout package. Stock markets and the Euro declined in response to Standard & Poor decreasing the debt rating to BB+, essentially a junk rating. In May a series of austerity measures were implemented, which were met with rather minor objections. Greece’s bailout occurred at the same time as the one in Portugal.

The bailout has not seemed to work very well, and Greece is in danger of defaulting on its loans. The original problem came from the fact that the government had for years estimated the budget deficit rate at was at 6-8% of GDP. The new Socialist government in 2009 revised this to 15.4%. This, along with massive increases in personal debt, led to increased borrowing costs. There are also concerns that Greece has tried to cover up the extent of its debt in the midst of the recession.

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