The Euro Crisis For Dummies

By Julian Knight

The crisis in the Eurozone is one of the biggest news, political, and economics stories of this generation.

Already affecting millions of lives in Europe, the potential for further economic turbulence, job losses and political wrangling means that the Euro crisis is a story set to run and run.

The big idea behind the EU (European Union) and ultimately the Euro is a simple one. If you get nations to share their institutions and trade, then they are less likely to go to war. Co-operation not confrontation was the order of the day, and this has worked, as there has been peace in Western Europe for nearly seventy years and counting.

Despite its problems the Eurozone is the biggest economic block in the world. The theory is that the bigger your economy and the more your currency is traded, the less likely you’ll be prey to currency speculators and the more stable the value of your currency. And this makes it easier and cheaper to trade with the rest of the world. The Euro is the second most-traded currency in the world behind the US dollar. Having a strong, stable currency is considered desirable as it helps businesses plan for the future and trade with each other without the fear of a sudden fall in the value of their own currency. Stability is what all businesses and governments want when it comes to currencies.

Many commentators suggest that the building of the Euro was slightly rushed and that countries that weren't quite ready (especially in terms of controlling government spending) were allowed to join too soon, weakening the Euro and prompting the crisis.

Eleven countries entered the Euro in 1999; these were: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain. In addition and at the same time, Europe’s tiniest state currencies of Monaco, San Marino and the Vatican City were also replaced by the Euro (although these states don't count as Euro members). Since 1999, six other countries have been allowed to join: Greece, Slovenia, Cyprus, Malta, Slovakia and Estonia.

But it’s only since the global financial crash of 2007 and 2008 that the Euro has started to slide into the danger zone. In fact up until this point most commentators considered the Euro a success.

Although the Eurozone only has one currency, each individual member state of the Euro manages its own public finances and issues its own debt for investors to buy.

Normally when an economy is in recession, the value of the national currency falls making exports cheaper. This helps firms sell goods abroad, boosting growth and solving the economic problems. This is called currency devaluation.

However, the problem for the PIGS – and some other members of the Eurozone – is that they no longer have a national currency to devalue.

In fact, some experts say that if Greece were to leave the Euro and re-adopt the Drachma it would see a radical devaluation, which would boost exports and make tourism cheaper (which is vital to Greece and other Mediterranean economies).

The big danger is that the PIGS economic crisis is now spreading across the Eurozone, which may mean that the single currency fragments as nations re-adopt their old currencies in order to devalue.

It’s not just the PIGS that are in trouble. Several other Eurozone nations have over-borrowed and may have difficulty keeping up with their debt repayments. These include Italy and even the world’s fifth largest economy: France.

For good or ill, Britain’s economic life is tied to the continent of Europe and in particular to those countries which have the Euro currency. So what goes on over there really makes an impact over here and across the global economy as a whole.

Most of Britain’s trade is with Eurozone countries. If they are in economic crisis or recession then it’s very likely that the UK will follow suit.

Much of the Eurozone countries’ government debt is owned by banks. Now, Britain is at the heart of world banking; it makes up nearly 15 per cent of our economy. If Eurozone countries can't pay back all their debts or if the Euro collapses, the banks will struggle to get their money back and this could mean yet another government bailout for the banks (as happened in 2009).

Britain may be in the front line of the Euro crisis but we aren't the only country affected. The Eurozone is a massive market for businesses from the US, China, India, Japan, Russia and other major world economic powers.

A collapse in the Euro or some European governments being unable to repay their debt (called a default, see later in this Part for more information) would have a huge negative impact on the world economy much like – or likely even worse than – the financial crisis of 2007 and 2008.

A global economic recession would be highly likely.

Not everyone is agreed as to what course the crisis will take, but here are the main options for the future:

The Euro muddles through: This is the option favoured by most politicians. Basically, the hope is that the stronger nations (such as Germany) will come to the economic aid of the weaker ones.

The Euro suffers a limited break up: Under this scenario countries such as Greece and possibly Portugal and Ireland will leave the Eurozone and start to issue their own currencies again. The rest of the Eurozone continues as it was.

The Euro suffers a substantial break up: This is the same scenario as shown in the previous bullet, but more major countries (such as Italy and Belgium) go as well. This will leave a rump of nations behind, but these would be the ones in the strongest financial and economic position – making it more likely that the final doomsday scenario will be avoided.

The Euro suffers a full break up: All bets could be off if this occurs. Basically, every country goes its separate ways, re-issuing its old currencies. This could lead to widespread chaos and economic panic not seen in Europe since the Second World War.

The future of the Euro is intrinsically linked to whether or not the government debt of member states is wrestled back under control.

In a bid to reduce the amount they’re borrowing, governments across the Eurozone and Britain have been taking often painful economic measures including:

Cutting public spending:

Sacking public sector workers:

Fixing the state pension:

Increasing taxes:

Reducing government debt (known as austerity) is a finely balanced operation. Cut too deep and it could send the economy into recession (which has happened in Greece and Ireland), which in turn reduces income from taxes and can mean more not less borrowing in the short term.

The British government’s plan to tackle debt is very controversial, with critics suggesting that public spending is being cut too far and too fast. But supporters and major economic bodies, such as the International Monetary Fund, have praised Britain for grasping the nettle and trying to get its debt under control

Knowledge is power and the more informed you are, the better you’ll be able to understand what’s going on and cope if the crisis deepens.

The UK government in 2011 borrowed more than Greece and the economy is at best sluggish. Meanwhile, the Eurozone accounts for the majority of Britain’s overseas trade and many British banks hold billions in government debt from Eurozone countries. As a result, Britain is right in the Euro crisis firing line.

With Europe’s biggest population, economy and healthy government finances, Germany is the powerhouse of the Eurozone.

Because of Britain and America’s addiction to credit cards and borrowing to buy property, personal debt levels are actually higher in these countries than the Eurozone. In fact, your average French, Italian and even Greek person is far less indebted than your average Brit or American.

The final cost of the global financial crisis of 2007 and 2008 has been estimated at $3 trillion. That’s a mind-boggling sum and much of it was funded by governments around the globe, borrowing in order to pump money into their banks, which were on the edge of collapse. At the same time economies around the world fell into recession and tax revenues collapsed. A big financial black hole was created and it still hasn't been filled; if anything it’s getting larger.