I’m not an economic wizard either, but I do know that a state has to be in charge of its own currency to exact control over its own domestic economy. Entering the corrupted EU with cooked books –which was of common knowledge by all the self appointed ruling elites that gave the nod for the Greek economy to enter the monetary union- shows the contempt (self deemed) ruling elites have for the European taxpayer.
This piece goes a long way in describing (in plain English) the mess the EU is in, and how to get out, much of which the TT has been saying for some time now. End the common currency, end the European Union as it is. KGS
IDIOT’S GUIDE TO THE EURO CRISIS
Friday November 11,2011
By Simon Edge
WE seem to be peering over a financial precipice but it’s one that is so obscured by jargon that very few of us can see the sides of it, let alone the bottom. You may think you’re the only one who doesn’t know what a bond yield or a debt rollover is but you’re in good company.
Greece’s outgoing premier George Papandreou, who has a master’s degree from the London School of Economics, has admitted he only recently learned what a credit default swap was.
It would be too glib to say in that case it’s not surprising his country is teetering on the verge of bankruptcy. The point is that all this stuff is bewildering in the extreme.
So hopefully our simple guide will help you understand …
How do countries borrow?
If you have money in a savings account you are essentially lending money to the bank or building society.
The interest you get is your fee. You can usually get a higher rate if you put your savings in a fixed-rate bond.
That’s where you give the bank your money for a fixed term, typically one to five years, and you get a guaranteed rate of interest paid at pre-arranged intervals.
Bonds are also what governments use in order to borrow cash. Instead of individual savers like you or me, the lenders are commercial banks or institutions such as pension funds.
The borrower–Italy, Portugal, Greece or Britain–issues a bond (ie borrows the money) for a fixed term, undertaking to return the cash at a pre-determined point.
Throughout that time it will pay a fixed rate of interest agreed at the start of the loan.
Why have these bonds suddenly hit the headlines?
When 11 European states ditched their currencies for the euro in 1999 (followed by six more countries later), they allowed the new European Central Bank to set monetary policy in the new “eurozone”.
This was good news for the weaker economies. Effectively guaranteed by their stronger partners, they found they could borrow money at much more favourable rates of interest than before.
Fuelled by this cheap credit, countries such as Greece (which had an Olympic Games to stage), Italy, Portugal and Ireland embarked on an orgy of spending.
In practical terms it meant they issued lots and lots of government bonds.
So what went wrong?
As we discovered in the New Labour years, politicians find it very easy to spend their way into their voters’ good books, knowing that paying the debt back will be someone else’s problem.
In Greece and Italy much of the borrowed cash went on public-sector wage rises.
In the global financial meltdown that followed the collapse of Lehman Brothers bank in 2008 all economies contracted and it became painfully clear that the governments of the weakest countries in the eurozone had precious little means of paying back the money.
The debt totals in question are massive. While Britain’s entire debt is around 63 per cent of gross domestic product, Italy’s is 120 per cent and Greece owes 160 per cent of GDP.
That’s like having an income of Â£20,000 a year and debts of Â£32,000 on your credit card. And the point of bonds is they need paying back on a specific date. Not doing so is defaulting.
Has anyone defaulted yet?
No, but several countries have come pretty close. With those 10-year bonds maturing virtually on a daily basis, there is always someone needing their money back.
For heavily indebted economies that are spending far more on salaries, services and debt interest than they are raising through taxes, the only way of honouring the debt is to resort to fresh borrowing and suddenly the terms have become much tougher.
For once it is hard to blame the banks for that. With lending to these countries suddenly looking a much riskier proposition, it’s hardly surprising that the lenders are jacking up the rates of interest.
Why is defaulting a big deal?
If a government defaults on just one bond repayment, the effect will be catastrophic. No lender in their right mind will loan it the money it needs to carry on paying public-sector salaries and the country will run out of cash very quickly.
Countries that control their own currencies can start printing money (as the Bank of England has been doing, under the euphemism “quantitative easing”) but members of the eurozone can’t do that because monetary policy is controlled by the European Central Bank rather than in Athens or Rome.
What are bond yields?
This is one of those confusing terms that make the situation seem impossibly technical. But it’s worth mastering because rising bond yields are a sign that a country is getting into deeper and deeper trouble.
The yield is the return a lender can expect to make on a sovereign debt issue.
In the simplest case it’s basically just the interest as a percentage of the original loan.
But there’s also a secondary trade in government bonds–if I start losing confidence that I’ll get my cash back at the end of the loan period I may prefer to cut my losses and sell the bond at a discount to someone else. For the new owner of the bond that pushes the yield up.
Bond yields rise when lenders sell off their bonds and they are therefore the equivalent of a plummeting share price.
This week the bond yields on Italian sovereign debt passed the seven per cent mark, which economists regard as the upper limit of repayability. That’s why it all looks so serious now.
If it’s just the eurozone, why should we worry?
It’s hard to overstate the potential hazards. Greece has already had two massive bailouts to stop it defaulting, and Ireland and Portugal have had one each.
This basically involved the European Union and the International Monetary Fund stumping up further loans on easier terms on condition that the governments in question enacted tough austerity measures to try to reduce their debt.
The donors weren’t doing this out of the goodness of their hearts. Greek, Irish and Portuguese sovereign debt is held in British, French, German and US banks which could be severely weakened if those countries started defaulting on their capital repayments. The domino effect doesn’t bear thinking about.
Even if default is avoided, the eurozone economies are already suffering as austerity measures kick in and consumer demand slows. With 40 per cent of Britain’s exports going to the eurozone, recession there is the last thing we need.
How bad is it going to get?
The crisis in Italy is seriously scary. While Portugal, Ireland and Greece received bailouts because they were regarded as too big to fail, Italy–the third largest economy in the EU and the eighth largest in the world–could be too big to save.
The only course of action may be for the ECB to print euros and buy up Italian debt, which the Germans have been resisting because it smacks of the last frantic days of the Weimar Republic.
Another option would be for Italy to leave the euro.
It could return to the lira which it could devalue thereby reducing the cost of its exports and establishing the conditions to rebuild its economy.
Such eurosceptics as MEP Daniel Hannan say this might actually be the best hope, reducing the national antagonisms which are said to be soaring within the EU as a result of this extraordinary crisis.
Josh W. writes:
The reason that the euro benefits the weaker economies is that creditors are protected from a weak country’s central bank simply printing more money (“quantitative easing”), which would devalue their currency. With their currency devalued, tax revenue increases (in terms of their currency only; obviously not in absolute terms), which enables them to pay back their debt.
Of course, the actual payment received by creditors is worth much less in absolute terms, which would likely amount to a net loss from the investment in the weak country’s bonds. Because the Euro is controlled by powers external to the weak economies (meaning that the weak country cannot “quantitatively ease” or devalue it), the creditors know that this sort of cheating cannot happen without the entire Eurozone being complicit in it.
Thus, whereas a weak country in control of its own currency would have to pay a high interest rate on its bonds for the relatively high risk of its currency being devalued, a weak country can borrow Euros for a much lower interest rate because its creditors assume that the currency can only be devalued if the stronger economies of the Eurozone were to agree to such a move, which they would almost certainly never do. This assumes, of course, that the country will not simply go bankrupt–which is turning out to be a not-so-wise assumption.
Debra C. writes:
Regarding how being part of the Eurozone enables less fiscally stable nations to borrow at lower rates: Think of the stronger economies as being co-signers; the very fact that a solvent entity will be on the hook for the amount borrowed enables the weaker countries to borrow money at lower rates–the loan will be covered by the stronger entity in case of failure to repay.
Which is moral hazard on steroids, isn’t it, when it comes to fiscally irresponsible borrowers? It only feeds their propensity to live beyond their means. At some point, critical mass is reached and the entire boondoggle at last blows up in everyone’s face.
At least that’s the way I understand it.