The Euro’s Next Crisis | Why an early election spells big dangers for Greece—and for the euro

[More Context Into Greece, PIIGS, & Eurozone Crisis]

Before the Crisis:

Before the Eurozone was formed in 1999, rates averaged between 4.5 and 6 percent. The exception: Greece, which was paying 8.5% to borrow. By 2003, Greece and Italy were borrowing at 4.3%. France, Germany, Spain and Portugal were at 4.1% -- meaning Greek and Italian bonds were seen as only marginally risker than French and German Bonds. Low interest rates fueled domestic spending and spurred inflation in wages and goods, which in turn made their exports more expensive and left imports relatively cheaper. Manufacturing became uncompetitive and nations that had roughly balanced trade in 1999 began running large trade deficits instead.

The Crisis Strikes | The PIIGS:

In 2010, Greece’s rate jumped to 9%. Germany was at 2.7%, with France at 3.1%. The rate of troubled Ireland and Portugal neared 7%. By 2011, the picture was grim: Germany was at 1.83% while the PIIGS countries interest rates continued to climb. If the PIIGS (Portugal, Ireland, Italy, Greece, Spain) defaulted on their debt, their bondholders would take a ‘haircut’ on the value of their debt. Since these bondholders were largely banks from elsewhere in the Eurozone, this option offered the prospect of a EU wide banking crisis.

If one of the PIIGS (e.g. Greece) left the Euro, its currency would plunge, giving a competitive boost but boosting also value (relative to GDP) of its Euro-denominated debt (hence making a default more likely). There was also a fear that allowing one Eurozone member to leave would lead speculators to focus on other weaker Eurozone countries.

Austerity & Bail-Outs:

Thus, a decision was made to bail out the weakest PIIGS out: First the ECB began intervening in the secondary debt market to buy Greek, Irish, Portuguese, Italian, and Spanish bonds. Second, the EU together with the IMF put together loan packages at competitive rates of interest, for the Greeks, Irish, and Portuguese. These loans were conditional upon drastic austerity measures leading to mass protests, strikes and occasion street violence in the affected countries. Spain and Italy, while not receiving loans, were compelled by the ECB to implement steep austerity

The European Stability Mechanism's (ESM) aim is to indicate to markets that the EU will throw a lifeline to countries in distress and hence to stay speculation against weaker member states’ bonds. However, the sheer scale of the debt problems of the Mediterranean member states led to market pressure for an increase in the size of the fund. Turning the EU into a ‘transfer union’ in which the currently weaker countries receive the regional support of their stronger brethren, is deeply unpopular in Austria, Finland, Germany, and the Netherlands, however.

The Fiscal Compact:

Thus, these countries insisted that a new treaty be drawn up to prevent a recurrence of this crisis. On march 2, 2012 twenty-five of the EU’s then 27 member states (Britain and the Czech Republic opted out) signed a treaty to co-ordinate their budget policies and impose penalties on rule-breakers – the ‘fiscal compact’.

The New Treaty Called For: A “balanced budget rule” (limiting structural deficits to 0.5% of GDP) to be incorporated into national legal systems, at a constitutional level or equivalent. The European Court of Justice to check whether nations implement the budget rule properly – it will fine them up to 0.1% of national output (GDP) if they fail to do so. Plans for bond sales and all major economic reforms are to be reported to the EU institutions in advance. Eurozone summits are to be held at least twice a year.

The Eurozone Crisis 2012-2013

Feb 21, 2012 Euro-area finance ministers reach agreement on a second bailout package for Greece (130b). The deal includes a 53.5% write-down for investors in Greek bonds. July 20, 2012 Spain receives 100b of EU loans to prop up its ailing banks. Aug 2, 2012 The ECB announces it “may undertake outright open market operations” (i.e. additional purchases of government debt), but only if those governments meet several “necessary conditions”. Sept 6, 2012, The ECB commits its balanced sheet to unlimited, but conditional, purchases of short-dated Eurozone government bonds. March 25, 2013 In return for a 10b bailout from the EU and the IMF, Cyprus agrees to drastically shrink its outsized banking sector, cut its budget implement economic reforms and privatize state assets. 


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