The European Economic Crisis

A Paper Submitted to Webber International University
In partial fulfilment for the
Bachelor of Science Degree in Finance

By: James Holt Date: November 26, 2013 Course: ENG112-1 Semester: Fall 2013 Instructor: Professor Nancy Davis Word Count: 2663

The European economy is in turmoil. The credit crunch in 2008 caused chaos throughout the global and European economic systems and highlighted the negligence of not only governments but also the financial systems in place. In the highly praised publication the Economist the author G. Tett writes “The European economy is in the midst of the deepest recession since the 1930s, with real GDP projected to shrink by some 4% in 2009, the sharpest contraction in the history of the European Union. Although signs of improvement have appeared recently, recovery remains uncertain and fragile” (Tett, 2013). A publication of this magnitude publishing this shows the utter chaos in the European Economy. The economy of all countries within the Euro has been greatly affected; it has also affected the surrounding countries around the Eurozone. The stronger European economies have recovered a great deal these include Germany, Sweden, England, France, Switzerland, Norway and Denmark. These countries have the most efficient systems and are the richest countries in the EU. The majority of the countries which are not part of the Euro and do not use that currency as a medium of exchange recovered the quickest, this is because they were not linked to countries with poor regulations and unstable governments. England is still in a very unstable economic state, however it is a rich country so it should continue to progress and the Economy should gradually improve. Sweden, Switzerland, Norway and Denmark have always been strong economically, mostly because of the abundance of natural resources at their disposal, they have some of the highest rated currencies in the world and they refuse to be part of the European Monetary Union, this has undoubtedly helped their economic recovery. Germany is the anomaly of the euro countries, it has one of the biggest GDP’s in the world, its industries are thriving and their productivity is unquestionable, this is the only reason they are not a struggling economy compared to the other euro countries. The other euro countries however are not in the same state as Germany, many are currently being bailed out by the European Monetary Union, and this includes Spain, Portugal, Ireland, and Greece. The republic of Ireland suffered badly during the credit crunch because it had an economy, which was vastly run by the housing market, a reduction in credit for investments put the housing market to a halt, and this caused mass unemployment and huge debts to occur. The republic of Ireland has been given bail out money by the ECB (European central bank) and the IMF (International Monetary Fund) to pay its debts and to pay welfare to the poverty-stricken citizens, but they are not dependant on this money and the government is reducing the deficit and are on schedule to not need bail out money by 2014. There have been various articles written on this subject a short snippet of one it this “Irish Prime Minister Enda Kenny had announced before the meeting that his country would begin raising its own money and financing itself again by late January or early February” (Kaiser, 2013). Spain and Portugal have very volatile economies at the moment and a huge government deficit is crippling their economies, unemployment is sky rocketing in both countries and both were victims to over investment in the housing market which caused mass over development of sought out tourist areas e.g. the Algarve and the Costa Del Sol, the credit crunch had a similar effect here as it did in Ireland with many investors pulling out and overall investment dropping many projects stopped without finishing and have been abandoned, this has caused huge unemployment rates throughout the construction industry and it has effected many others. The main issue with Spain is that its banks are badly in debt, they acted with little regulation and acted brashly up to the credit crunch, they did not leave themselves any security. The struggling banks have caused more issues because the government has had to help them when the money is badly needed in other areas i.e. welfare. A recent statistic of the state of the general public in Spain and its employment rates are shocking, especially young people under the age of 25 “Family networks keep the working class going as unemployment hits 26%. Fewer than half of those aged under 25 find work”(Tremlett, 2012). The Spanish government has said it is expecting to end the bailout program from the ECB, after predicting the banks will no longer need bail out money but surely with the poverty in Spain that money could be spent on welfare systems. Another article commenting on the Euro Bail out schemes has said, “Spain, too, is expecting an end to its bailout program, which was given straight to struggling banks rather than the government”(Kaiser, 2013). And that Portugal is also set to exit the bail out mid 2014 “The country's 78-billion-euro bailout formally ends in mid-2014 when Portugal should return to financing itself normally in bond markets, which it stopped doing in 2011 when its debt crisis first hit”(Goncalves, 2013). This is good news for European markets and all members of the Euro because it will increase confidence within the currency and this will lead to increased investment. Increased investment should realistically increase job opportunities and increase the value of the Euro. But for the Portuguese people hard times are ahead “the budget promised heavy spending cuts to hit public sector wages and pensions in 2014 as harsh austerity continues to take its toll on the country which has gone through its worst economic crisis since the 1970s under the bailout” (Goncalves, 2013). The Portuguese people are going to suffer greatly through the time of austerity but reducing government spending on welfare programs and having higher tax rates to try and distribute wealth across all wealth classes is something that cannot be avoided in the long run if the country wishes to be economically stable. Greece is another country which is struggling economically and have even considered switching currencies from the Euro back to the Drachma however no plan was put into place for leaving the Euro when it was first commissioned so it is very complicated. The government has played a huge part in their economic state and there have been various riots and protests against the government and its negligence in recent years, undoubtedly Greece has the worst economy in the Euro Zone. The officials in Brussels (ECB) are very worried about Greece’s chances of defaulting and the ever-increasing government debt in the country because of its massive effects on investment confidence throughout the Euro countries. “The “troika” of officials from the European Union, the European Central Bank and the IMF are pressing for new measures to plug a gap of about €1.5 billion ($2 billion) in the 2014 budget. The government says the shortfall is only €500m-700m and can be covered by cracking down on employers who evade paying social-security contributions. The troika is skeptical, as the finance ministry has missed all its previous targets for collecting unpaid taxes” (Economist, 2013). There are growing tensions in the Euro Zone with the negligence of the Greek government. It is true that measures of austerity have caused unrest within the country and the public believe it is the governments fault for applying some austerity measures, however; the publics excess on spending and private debt is also huge and this is why many people within the nation have found it hard to cope with the measures introduced by the government to try and reduce the deficit. Personally I believe that the Euro is hindering many economies, unquestionably the interest rates set for the Euro by the European Monetary Union favour the German economy, this means that their economic reacts more positively but it has negative impacts on other countries in the Euro Zone, also England donates money to the bailout programmes which greatly reduces the chance of a full economic recovery because they have a huge government deficit already. The UK government is finally standing up to the IMF and resisting handing over more money to help other countries when the UK’s economy is still volatile. The Prime minister after attending a recent ECB meeting has declared that the UK will not pay as much to the IMF any more “David Cameron will resist any attempt by Eurozone countries to press Britain to hand more cash to the International Monetary Fund to help fund a euro-bailout fund”(Wintour, 2011).
There have been a variety of factors, which built up to the credit crunch, and the market crashes throughout the world and Europe but I believe the main one is negligence by governments and people living beyond their means. The U.S along with many other governments did not act as efficiently as they should have and when they did they didn’t act drastically enough “The Greenspan Fed kept interest rates too low for too long” “Every time officials at the Treasury or the Fed thought they finally had gotten ahead of the Great Panic, they turned out to be insufficiently pessimistic. This would be a distinguishing characteristic of this chapter in American economic history: even when officials thought they were planning for the worst-case scenario, they weren’t”(Wessel, 2013).
If governments had foreseen a possible credit crunch occurring, like many well-known financial experts did, the fall out of it would have been reduced greatly. Governments consistently ran up deficits and increased the debt ceiling for many years, when the credit crunch occurred governments and businesses were refused loans and this caused havoc on financial systems. If proper regulations were put in place this would not have happened. Another huge player in the cause were the banks, year after year they paid out huge bonuses even to people who had made losses on the banks investments, it was very rare to be refused a loan by a bank in the years running up to the crunch because people with poor credit states could default and then the banks would foreclose, they could easily sell on the house making a profit because the housing markets were growing rapidly. This never ending stream of loans worked when the economy was good, but it was exasperating all forms of credit and eventually it had to run out. “The credit crisis had been brewing for a number of years, as rising interest rates in the US and Europe led an increasing number of low-income homeowners on sub-prime mortgages to default. But the pivotal moment arrived when a French bank issued a statement that most would consider arcane – but which would have profound consequences” (The Guardian, 2010).
The initial statement by BNP Paribas was originally believed to be lies, and had been blown out of proportion and not many could foresee the aftermath in economic unrest after this statement “BNP Paribas told investors in two of its funds that they would not be able to withdraw money because it was no longer able to value the assets in them, due to a "complete evaporation of liquidity" in the market” (The Guardian, 2010). This was the beginning of the credit crunch. Economists at the time had made analysis’s and came to the conclusion that money was to cheap and far too liquid one economist said this "Money was virtually free – in the case of Japan, where it had zero interest rates, it was literally free – and it was available in limitless quantities, which does not correspond to any definition of normalcy, so that created a bubble and bubbles burst" (The Guardian, 2010).
The main problem for banks was that when the credit crunch occurred so did the huge crash in housing markets this means that when someone defaulted and they foreclosed they could no longer sell the house to another customer. These reasons meant that banks ran up huge debts and they almost went bankrupt, many being bailed out by the government. The most famous being Northern Rock. This could have been easily stopped if the managers at banks had been more efficient and were not so relaxed, regulation should have been in place so that they could not give loans to people who had a poor credit history “a deeper analysis of the dynamics underlying the current Euro crisis shows that financial deregulation and liberalization was a major cause of the crisis in periphery countries in the Eurozone” (Treichel, 2013).
Politicians and economists have said that the capitalistic and greedy approach to business and financing economies has caused huge problems and that changes need too occur to stop disasters like this happening in the future but their have been a lot of false promises and I believe this is very negligent, undoubtedly it is hard to enforce strict regulations on banks, and strict austerity measures without falling out of popularity but changes need to be made before another financial crisis happens, and we are still on the brink of one if public and private debt continues to accumulate the availability of credit will shrink rapidly “But three years on, for all the hand-wringing, the economic upheaval and the promises of politicians, there is a whiff of business as usual in the air. The banks have returned to substantial profit, City bonuses are moving back to dizzying heights, international efforts for further co-operation have largely come unstuck, cranes are once more rising over the Square Mile and house prices are moving north” (The Guardian, 2010). Another contributing factor was that the general public got used to a lifestyle of living beyond their means and racking up huge debts on their credit cards, with no thought of the consequences. People in today’s society have been greedy and this needs to stop. Many people point fingers and blame government debt for the crisis but it was a mixture of both private and public debt, also it shows private debt had a huge impact on the crisis because many countries in recession now had huge private debt in comparison to the public debt “In fact, Spain and Ireland had very little government debt when the global economy sank in 2008. But they had huge levels of Private Debt, all connected to the Housing Bubbles” (Clark, 2013). Some may see it as unfair but people with low paying jobs have got to live a much less glamorous and luxurious lifestyle than others with more disposable income. It is not prejudice to say so; it is the only way economies can run efficiently. The economy in Europe has improved over the recent year over all but countries like Greece, Spain and Portugal are having huge effects on investor confidence, this is hindering the economy greatly.

References:

Clark, M. (2013). PRIVATE DEBT CAUSED THE CURRENT GREAT DEPRESSION, NOT PUBLIC DEBT. (Original work published 2012). Retrieved from http://seekingalpha.com/instablog/428250-michael-clark/605631-private-debt-caused-the-current-great-depression-not-public-debt.
Goncalves, S. (2013). Portugal to cut state wages in 2014, exit bailout. (Original work published 2013). Retrieved from http://www.reuters.com/article/2013/10/15/portugal-budget-idUSL6N0I53Q920131015.
Kaiser, S. (2013). Euro Crisis Reprieve: End to Bailout Programs Signals Recovery. (Original work published 2013). Retrieved from http://www.spiegel.de/international/europe/end-of-bailout-programs-in-spain-and-ireland-signals-euro-crisis-recovery-a-933650.html
Tett, G. (2013). Fools Gold. U.S.: Abacus. (Original work published 2010).
The Economist. (2013, November 16). 2013. Retrieved November 18, 2013, from http://www.economist.com/news/europe/21589893-hard-winter-lies-ahead-greek-government-little-respite
The Guardian. (2010). Credit Crunch Consequences. Retrieved October 6, from http://www.theguardian.com/business/2010/aug/08/credit-crunch-analysis
The Economist. (2013, November 16). 2013. Retrieved November 18, 2013, from http://www.economist.com/news/europe/21589893-hard-winter-lies-ahead-greek-government-little-respite
Treichel, V. (2013). The Crisis in the Eurozone. (Original work published 2013). Retrieved from http://www.worldfinancialreview.com/?p=2303.
Tremlett, G. (2013). Spain: the pain of austerity deepens. (Original work published 2012). Retrieved from http://www.theguardian.com/world/2013/jan/01/spain-pain-austerity-deepens.
Wessel, D. (2013). In FED We Trust: Ben Bernanke's War on the Great Panic. U.S.: Crown Business. (Original work published 2010)
Wintour, P. (2013). UK to resist calls to give IMF more funds for euro-bailout. (Original work published 2011). Retrieved from http://www.theguardian.com/business/2011/dec/14/uk-resists-calls-imf-bailout.