The European Debt Crisis is Still Alive and Kicking

For those with memories longer than the time it takes to read this article, the month of May is quickly approaching, and with it, the one-year anniversary of not only the “Flash Crash”, but also the moment when the European Debt Situation grabbed financial headlines, causing an immediate crisis of global proportions.  Capital suddenly flew to safe havens in the form of treasury bills and precious metals.  The Euro fell from its lofty perch relative to the greenback, and “PIIGS” was a euphemism that forever joined our daily lexicon of favored terms.

The Euro had strengthened from its debut to the $1.60 range, but the recession pulled it back.  As it began to recover afterwards, it staged another assault, rising to $1.51 until news of debt problems surfaced at the end of 2009.  In May, the full import of the debt problems became common knowledge, and the downdraft plummeted the Euro to its lowest value in four years, a startling $1.18.  Greece was the initial focus, but then the malaise spread to concerns over Portugal, Ireland, Italy, and Spain, the remaining members of the “PIIGS” anagram.

TIME TO GO ON A DIET

Bail out programs and promises of austerity programs ensued, but, one year later, the same basic issues remain.  This is not just a case of whether the Euro is a better currency than the Dollar.  The core issue relates to whether Western economies can generate the growth necessary to increase domestic tax revenues and pay down astronomical national debt and deficit values.  The “EUR/USD” forex battle is an interesting sideshow, but the issues continue to perplex government officials on both sides of the Atlantic.  Relative changes in the two currencies only reflect minor differences in the success or lack thereof of economic recovery programs in each region.

Debt is the battleground today, and the war needs favorable results to encourage market participants that the battle is being won.  Standard and Poor’s shot a signal over the bow of Capitol Hill suggesting that the pristine “AAA” rating of U.S. debt may be revised downward in the not-to-distant future if something is not done to address it.  Markets fell, as reasons for concern became a distinct reality rather than a shadow within denial.

The debt situation in Europe appears to be ameliorating, if you believe the statements of Carlo Cottarelli, head of the IMF’s fiscal affairs department.  After acknowledging that fiscal risks to the global economic recovery are still Euro-centric, he commented that, “If I look at fiscal fundamentals, I see the situation in Europe improving faster than in the U.S.” Are these words to be taken at face value or are they just another attempt to assuage public doubt without significant substance behind them?

Yes, bailout programs have been established, and Greece and Ireland have been dealt with in orderly fashion.  Portugal is next on the “hit parade”, but there is already social unrest and governmental back peddling on proposed austerity measures.  Spain is not out of the woods either.  A real estate “bubble”, similar to here in the States, has left banks and individuals deep in debt with assets underwater from a mortgage perspective.  The general belief is that the entire dimension of the overall debt problems has yet to be determined, and the acceptance of the level of bailout programs by Germany and France is beginning to wane.

ONE CURRENCY, NO ESCAPE

The European debt crisis has underscored a basic problem in the framework behind its single currency, the Euro.  The European Union may have consolidated behind the Euro, but actual control of trading policy, resulting imbalances, and related deficits remained firmly in the hands of each member state.  The “PIIGS” represent the net-importing states, while Germany, The Netherlands, and France are the large export engines that keep the Euro strong.  However, credit ratings were handed out evenly when standards should have varied by region.  Over borrowing ensued and now must be paid down.

For the past few months, the Euro has strengthened to $1.42, a reflection that Europe has progressed while the U.S. seems mired in Congressional deadlock.  Both regions need economic growth to materialize, but manufacturing capacity has already been off shored to Asia.  Welcome to the new world order.

Readers, what are your thoughts of the European Debt Crisis?  Do you think everything is under control, Germany will bail out everyone, and there will be no more contagion?  When will the US state debt crisis hit?

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    I think Mr. Cottarelli is whistlin’ past the graveyard. The Eurozone has some long-term problems that aren’t being addressed: lousy demographics (rapidly aging population), high public benefits, and a permanently unemployed and maybe unemployable underclass.
    I’ve long speculated that Italy will be the first to pull out of the Eurozone. The high Euro is just killing their exports.

  2. says

    The thing with a unified currency is that when they do well, they really do well! When they fall, they fall fast!

    The trouble starts when cracks appear in the perceived unity. What if Germany decides they shouldn’t have to bailout others? When ‘us’ vs ‘them’ syndrome sets in, it is a problem. They can’t do selective bailouts either – that’ll erode the trust in the union.

    It’s a tough situation for the EU and a good lesson for those wanting something similar. I know the BRICS recently concluded their meeting!

  3. says

    I agree with moneycome sometimes having a single currency is good and at other times it can be terrible. I think the world is going to be hit fairly hard because of our current view that everything is derived from consumer demand. In economics it’s always best to see things like demand go up, but for how long can we continue to grow and expand? Why is it such a bad thing to stay stagnant?

    -Ravi Gupta

    • says

      Ravi, Great point. How long can we continue to grow? This a finite planet with limited resources. I firly believe that the issues we are seeing in Europe are derived from the increasingly high cost of energy. Access to energy drives economic growth. Rising prices for oil restricts access and down goes economic growth. The problem with the Euro zone is that bankers stop lending them money when they are insolvenet, whereas the US creditors (China) keep on lending when we are broke…something t do with the US dollar being the sole reserve currency (not for long). It’s going t be fascinating to see if the Euro economis can restructure fast enough to avoid a major depression when the oil shock really hits.

      Hope this is not too doom and gloom.
      Hunter.

  4. Mike Hunt says

    Hard to say, with 2 year Greek bonds at nearly 20%, the market is predicting a chance of default. The poor countries like Ireland, Greece, Portugal are being saddled up with debt and having austerity measures so the citizens have to sacrifice to pay interest on their bonds to other bondholders in the rest of Europe and around the world.

    Iceland was smart, they told the IMF and the ECB to get stuffed and that they want their debt restructured (haircuts) or no deal. All that is needed is for the first EU troubled countries to stand up and do the same…. those are the first cracks in the facade.

    On the other side you have Denmark where an election was just won on the premise of no more bailouts.

    Right now the currencies are like the opposite of a beauty contest, the least ugliest will will. Sure, the USD has some really terrible fundamentals but I think the Euro will crack first and there will be a flight to safety into the USD. Only time will tell but I’ve voted with my feet so if I’m wrong I have my own money at risk unlike the bankers who gamble and get bailed out when they lose.

    -Mike

    • says

      I was so impressed to see 20% Greek bond yields! Sign me up baby since Germany will bail em out for sure!

      I don’t think either the USD or the Euro will crack. We are on a mending path… well, maybe not. Our state budget deficits are gonna screw us all!

      • Mike Hunt says

        The crazy thing is it is the Greek pension funds that are one of the major buyers of the bonds! But all the revenue even with austerity measures is being used to pay the interest!

        Not sustainable. Actually Germany and other ECB members will keep lending money at outrageous terms but eventually the debtholder has to default.

        Kind of like paying off your credit card with a higher interest one.

        It works for a while and then you go belly up really fast all of a sudden.

        So many shoes waiting to drop it’s unreal.

        But what the heck- the Dow is up so lets ignore all that and keep partying!

  5. Robert Muir says

    California, Illinois, etc. are in similar straights. Will the rest of the US bail them out or will they be allowed to default?

  6. says

    What I question is why no one ever talks about Japan in terms of a debt crisis. Their economy may be the next one in real trouble when you look at the recent tragedies, the lack of growth in their economy for the last 20 years, and their huge debt-to-GDP ratios. I think the USA and my home country of Canada are actually in relatively good fiscal situations if we continue on this current track to eliminate deficits and pay down debt.

    • says

      We’ve all already written off Japan for the past decade now. Demographics wise, it’s too hard to change for them. But, they will be fine b/c nobody expects them to be an engine of growth anymore.

      • Mike Hunt says

        It’s because all the bonds paying 1.5% are held by the Japanese… and there is a demographic time bomb going off as more seniors need to raise cash.

        For sure if Japan is selling to foreigners the yields will go higher.

        I heard that if all Japan bonds increase to 3.5% then the entire country tax revenue will be consumed in paying interest.

        Unfortunately this is where the USA is rapidly headed for as well.

        -Mike

  7. says

    Gosh, it’s hard to believe that was almost a year ago already. Time goes so fast. I think the US state debt crisis is already underway, at least in California. CA is a mess and the light at the end of it’s tunnel is a loooong way off.

  8. says

    It’s funny the Euro keeps rising against the USD. All the trouble in Europe and I think that this indicates trouble with the USD. Possible downgrade…The US borrows at 3% but if they get downgraded that rate will rise. There is too much debt with the government. Look at Greece and Ireland..they are a great looking glass.

  9. says

    I don’t have any predictions about Europe, but the U.S. still has quite a lot of work to do on the National budget. There have been some cuts, but really, we are overspending by 50% of our current income.

    Yep, if we don’t make some serious changes (which I believe Washington understands), then we’ll have our Flash Crash moment too!

  10. says

    I can’t see USA debt being downgraded either. That would trigger some really bad economic conditions aound the world and almost surely kill any positive momentum we currently have going. There are just too many really important people with too much to lose to have the interest rates climb. I shiver at the overall dollars that would be lost thanks to the massive debt that has been built up.

    I also think that Europe will get back in shape, it will just take longer. Germany will eventually tell the others to get in shape or their out. Without Germany at the centre of that union, investment would plummet. They just have to go through the cyclical socialist-conservative tug-of-war and they just shifted way too far left on the last go round to be sustainable.

  11. Mike Hunt says

    Removing the tax cuts on Americans making over 250k a year brings in another $40 B of revenue each year… we should remove the tax cuts on all Americans to bring in $400 B. Still would have a deficit of $1.2 Trillion, so need to get this down to less than 3% of GDP or $400B.

    The answer would be remove all the Bush tax cuts extension, restore Social security payments, and reduce spending / entitlements another $800 Billion – by means testing and reduction of security / defense spending.

    How much is the TSA spending to strip search 6 year olds? Unfortunately (or fortunately) we cannot afford it.

    -Mike

  12. says

    The real money to be made is in EURCHF, or USDCHF.

    I can’t predict what’s going to happen with the Euro or USD in the short-term, but I do know that the Swiss Franc is mostly overvalued in the long-run after everyone fled to it for its European exposure, and because it wasn’t the Euro.

    Long-term, the Euro is screwed. Throwing many different economies under one currency umbrella sure makes foreign trade easier, but it also ensures that you have monetary policy that only works for half the Eurozone half the time.

  13. Mike Hunt says

    How about going short the AUD, it is at new highs everyday. Today it is up to 1 AUD = 1.075 USD! Back in the 2008 crash it was 1 AUD = 0.61 USD, almost a clean double.

  14. says

    The current situation proves that the leaders of the countries which refused to pour more money into the rescue packages were right. The problem can’t be solved by continuing to incur huge debts in a hope that a miracle will happen in the end. There needs to be a number of structural changes brought about in order to improve the financial regulation of some of the European countries.

  15. says

    I read in an analysis by an Investment bank that the Crisis in UK is following the Crisis in US… Recession came first in US and the same streak of events happened when it came in UK… So UK will soon follow US as well when it comes out of Recession..

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