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Euro trashed?

Europe’s economic woes has

got the world on edge again

As the European Union (EU) continues to debate on how best to bail Greece out of a national economic meltdown, the rest of the world is holding its breath in case the eurozone crisis spirals out of control and causes a premature halt to the global economic recovery.


The road downhill starts in Greece

Greece is one of the member states of the eurozone, an economic and monetary union of 16 European Union nations that have adopted the Euro as their common single currency.


With its adoption of the Euro, Greece – one of the smallest economies within the EU – found itself with a newfound ability to borrow money at low interest rates thanks to the strength of the Euro currency. And so began the country’s borrowing and spending spree on various high-profile projects, including the 2004 Athens Olympics which cost the country an estimated €4.45 billion.1


But with rising levels of inflation and widespread tax evasion within its borders, the Greek government has now found itself in a situation where it has not made enough money to pay for the loans it has borrowed. And that has resulted in the organisations that provided Greece those loans to be worried. Foreign banks and investors who hold an estimated 70% – 80% of the Greek government’s debt, and Western European banks2 that hold the other 15% – 20% are at risk of seeing their money disappear into thin air with the country’s national debt ballooning to 115% of its gross domestic product (GDP), budget deficit at 13.6% of GDP, and showing no signs of getting any better soon.


The EU and International Monetary Fund (IMF) have stepped in to provide the first fix with a €110 billion bailout package in March 2010. But Greece will need to figure out fix number two; this will be the difficult one as it will involve huge cuts in government spending and raising of taxes – both of which could easily send the country’s economy spiralling downwards even further.


But the collapse of Greece alone would not crush the EU’s economy. It’s the knock-on effects and fears of other EU countries going down the same path that has the world worried.


More than Greece make the problem

Portugal, Italy, Ireland and Spain in particular, may also potentially fall into the same situation as Greece. Each country has announced various budget cuts and economic reforms to speed up the process for them to manage their respective country’s debts. These countries have been badly affected by the repercussions of Greece’s bailout, as both banks and investors have lost confidence in the reliability of investments or loans to countries within Europe.


Due to the current eurozone debt crisis, the banks have grown wary of issuing loans to other eurozone countries due to concerns of any possible debt defaults. As a result, the banks have started charging higher interest rates on loans to stem any possible losses, and the situation has grown increasingly difficult for countries such as Portugal to clear its sovereign debt. 


There are fears that Greek’s debt crisis will cause a ‘domino effect’ as Portugal, Italy, and Spain are countries that also show high debt to GDP ratios as well. While Spain is the fifth largest economy in Europe, Italy accounts for more than 20% of total European sovereign debt.


With Greece included, the combined debt to GDP ratio of these five nations is significant enough to cause an economic crisis that could spread throughout the eurozone and spill over into the global economy. While the EU may have announced a second €720 billion rescue package in May 2010 consisting of government-backed loan guarantees and a commitment to buy European sovereign bonds to stabilise the eurozone, it may still be only a stop-gap measure.


In order to contain their economic and financial problems, these five countries now have to balance new budgets that cut public spending and increase their tax revenues, and reduce their debts to the banks. But tightening their fiscal belts could easily stall the already tepid growth of these countries and cause them to head back into recession, and possibly pull the entire eurozone with them.


Perhaps a report by HSBC Global Research: depicts a clear picture: “In reality it’s just more of the same. The crisis has mutated [but] not been resolved.”4


What happens now?

Frankly, nobody really knows.


There are mixed views on whether the eurozone on a whole should put a squeeze on public spending so the rest of the EU countries don’t end up in a situation similar to that of Greece, Portugal, Italy, Ireland and Spain. Widespread public spending cuts could send the eurozone back into recession and pull the rest of the world economy into a double-dip recession. Others believe that the solution is for troubled countries like the aforementioned to tighten their belts while countries in good economic health like Germany to continue spending.


Greece has announced it’s budget, public spending cuts, and tax hikes. Spain and Ireland have announced austerity measures to cut the budget deficit. Germany has banned “naked” short-selling of government bonds. Whether any of these measures will stem the problem, we will have to wait and see.


What is evident is that EU members that can – meaning countries that are solvent – need to lend a hand and bail out the weaker links. As Joseph Stiglitz, the Columbia University professor and Nobel laureate, puts it: “The European Union should have a fund to help member nations in need of financial aid such as Greece. Deficit fetishism is a mistake.”


“In reality it’s just more of the same. The crisis has mutated

[but] not been resolved.” – HSBC Global Research


As for the rest of the world, including those of us in Malaysia and the region, we can only wait and see. Certainly, because Europe consumes a lot of the products and services originating from this region, if the eurozone crumbles there will be a spill-on effect. But as China, India, and even Indonesia have shown, if you can create enough domestic demand, or even regional demand for that matter, you can actually cushion the impact of an economic crash.


So if our own Malaysian market and demand remains strong, and the rest of the region together with other emerging markets continue to grow at the rapid pace seen in Quarter 1 of 2010, there is every reason to be optimistic that we will experience very little, if any, of the knock-on effects of the eurozone crisis.


1. Athens News Agency via “Cost of Athens 2004 Olympics” 13 November 2004

2. J.P. Morgan: “Market update and investment views on Greece’s contagion risk”

3. The Star: “Idris Jala: M’sia must cut subsidies, debt by 2019 or risk bankruptcy” 27 May 2010

4. HSBC Global Research: “Emerging Markets: A wall of worry that’s the tip of the iceberg” 5 May 2010


Eurozone crisis: A concise timeline

Europe’s economic woes has got the world on edge again


  • 05/11/2009

Greece’s new government announces 2009 budget deficit will be 12.7% of GDP, more than twice the previously published figure


  • 08/12/2009 

Fitch Ratings cuts Greek debt to BBB+, first time in 10 years it has been rated below investment grade


  • 22/12/2009 

Moody’s cuts Greek debt to A2 over soaring deficits


  • 14/01/2010

Greece unveils stability programme aimed at cutting deficit to 2.8% of GDP by 2012


  • 29/01/2010

Spain announces plan to save €50 billion through government spending cuts and public sector pay cuts


  • 05/02/2010

Spain attempts to raise retirement age from 65 to 67 triggering union protests


  • 05/03/2010

Greece announces new package of tax increases and public sector pay cuts to save an extra €4.8 billion; state-funded pension frozen


  • 25/03/2010 

Eurozone leaders and IMF agree to create joint financial safety net to help Greece


  • 11/04/2010 

Eurozone finance ministers approve €30 billion aid mechanism for Greece


  • 23/04/2010 

Greece asks for activation of EU/IMF aid

  • 27/04/2010 

Standard & Poor’s downgrades Greece’s debt to junk status; following day downgrades Spain’s debt due to poor growth prospects


  • 02/05/2010

Greece agrees to bailout deal with EU and IMF in exchange for additional budget cuts of €30 billion over three years; bailout package amounts to €110 billion over three years and is the first for a member of the 16 nation EU


  • 10/05/2010

Global policymakers set up emergency financial safety net worth €750 billion to bolster financial markets and shore up the euro against contagion from the Greek crisis


  • 13/05/2010

Portugal draws up steps to slash deficit including public sector pay cuts


  • 25/05/2010

Italian cabinet approves €24 billion austerity package to cut deficit to 2.7% of GD by 2012


  • 27/05/2010 

Spanish government approves €15 billion austerity package


  • 28/05/2010

Fitch cuts Spain’s credit rating on record household and corporate debt and mounting public debt


  • 07/06/2010

Germany approves budget cuts and taxes aimed at saving €80 billion over three years


  • 11/06/2010

Greece vows not to default on its loans


Eurozone’s sovereign debt

problem: A layman’s view


Borrowing money

Like any person, it is normal for a country to take loans. We may take a loan to buy a house. A country may take a loan to build a highway. 


Borrowing too much money

The problem with Greece, Portugal, Italy, Ireland and Spain is like a bank customer who has overextended himself by taking out too many loans and now finds himself without the required cash flow to pay off the loans.


When you are late on one payment here and miss another one there, banks get very concerned.


Paying back the money

So like any person caught in a financial fix, they need to immediately do a couple of things: firstly, find someone who will loan them money while they figure out how to fix the financial mess; and secondly fix the financial mess by finding ways to spend less and earn more. 


While ordinary bank customers can mortgage their home or sell their car to refinance their loans, these countries do not have the luxury of such a choice. And that is why they have to now depend on the bailout packages to make ends meet while they right their ships.


1. The Star: “BRIC economies to peak in 40 years” 22 May 2010

2. Goldman Sachs: “Is this the ‘BRICs Decade’?” 20 May 2010
3. Goldman Sachs: “The BRICs as Drivers of Global Consumption”

August 2010