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  • The European Debt Crisis -- Visualized

  • What is the European Debt Crisis ?

  • It's the failure of the Euro,

  • the currency that ties together 17 European countries in an intimate but flawed manner.

  • Over the past three years, Greece, Portugal, Ireland, Italy and Spain,

  • a ball teetered on the brink of financial collapse

  • threatening to bring down the entire continent and the rest of the world.

  • How did it happened?

  • Uniting Europe

  • For most of Europe's history, it's been a war with itself.

  • And countries at war with each other tend to do less business together.

  • Europe is always a continent of trade barriers, tariffs and different currencies.

  • Doing business across borders was difficult.

  • You needed to pay a fee to exchange currencies.

  • And you needed to pay a tariff fee to buy and sell to companies in other countries.

  • That tended to stifle economic growth.

  • Then came World War II, which devastated Europe.

  • Because the situation was so dire, the fastest way to rebuild Europe was to begin to remove these barriers.

  • Steel and coal tariffs came down so that a steel mill in one country could sell to a builder in another.

  • This gave the survivors an idea.

  • A unified Europe, a union across the continent that will end all future wars.

  • Countries began to band together toward this goal, bringing down trade barriers, lowering the cost of doing business.

  • One of the last barriers to fall was the Berlin Wall.

  • With the united Germany, Europe was ready.

  • 27 countries signed the Maastricht Treaty and created the European Union.

  • This made doing business across borders easier, but there was still one major obstacle: the different currencies.

  • A decade later, they had one.

  • The Euro, launched on January 1,1999.

  • Countries adopting the euro, called the euro area, discontinued their own currencies.

  • They also discontinued their own monetary policies, giving control to newly formed European Central Bank, commonly referred to as the ECB.

  • The euro area now have one unified monetary policy, but it still have many different fiscal policies,

  • a key reason for the current debt crisis.

  • Monetary policy versus Fiscal policy

  • You see it's important to understand the difference between monetary policy and fiscal policy.

  • Monetary policy controls the money supply, literally how much money there is in the economy, and what the interest rates are for borrowing money.

  • Fiscal policy controls how much money a government collects in taxes, and how much it spends.

  • A government can only spend as much as it collects in taxes.

  • Anything above that amount it has to borrow. This is called "Deficit Spending".

  • Before the euro, countries like Greece, not only had to pay high interest rates to borrow, but they can only borrow so much.

  • Lenders weren't comfortable lending them to much money.

  • But now that they were part of the euro area's new united monetary policy, the amount they could borrow skyrocketed.

  • Smaller countries suddenly have access to credit like never before.

  • Greece and other countries which previously could only borrowed at rates around 18%, could now borrow for the same low rate as Germany.

  • How?

  • Germany's credit card

  • You see, joining the euro area is a lot like sharing a credit card, Germany's credit card.

  • Lenders now believe that if Greece was unable to repay its loans, Germany and the other bigger economies of Europe will stepped in and repay them,

  • because they were now bond by a common currency.

  • With the new abundance of cheap credit, Greece and other European countries were able to adjust their fiscal policies,

  • and increase spending to previously impossible levels.

  • Some countries embarked on huge deficit spending programs, primarily for politicians to get elected.

  • They made promises such as more jobs and generous pensions, all that paid for with the new money they could now borrow.

  • The governments of Greece, Portugal, and Italy accumulated huge debts,

  • however, they were able to repay these debts with more borrowed money.

  • As long as the borrowing continued, so did the spending, and the unbalanced fiscal policies.

  • In Ireland and Spain, cheap credit fueled enormous housing bubbles just as it did in the United States.

  • Credit flowed, debt accumulated, and the economies of Europe became tightly intertwined.

  • Companies began opening factories and offices across Europe.

  • German banks lending to French companies, French banks lending to Spanish companies and so on and so forth.

  • This made doing business incredibly efficient, while at the same time tying together the collective fate of the Euro area.

  • Things continue this way as long as credit was available and credit was available until 2008.

  • Spurred by a collapse in the US housing market, a credit crisis swept the globe bringing borrowing to a halt. Everywhere.

  • Suddenly the Greek economy couldn't function.

  • It couldn't borrow money to pay for all the new jobs and benefits it created.

  • It couldn't borrow the new money it needed to pay its all debts.

  • This was a problem for Greece, but because of the unified monetary policy, it was also a problem for all of Europe.

  • Much of Europe have been on a spending spree and borrowed more money than it could ever repay.

  • But the problem is somebody has to pick up the tab or else every country in the euro area will suffer.

  • Since the countries that ran up the bill couldn't repay, everyone looked to Germany.

  • Austerity Measures

  • As the biggest and strongest economy in Europe Germany reluctantly agreed to help bail out the debtor countries.

  • In other words, Germany agreed to repay the bill but only if the debtor countries agreed to implement strict austerity measures to ensure that it would never happen again.

  • Austerity measures meant sucking it up, cutting spending, borrowing less and paying back more debt.

  • This sounds like a simple solution, right? It's not.

  • First of all, nobody wants austerity.

  • Austerity means cutting government spending, and since the government is by far the biggest spender in the economy,

  • when the government cut spending, it cuts the earnings of many of its citizens.

  • People lose jobs, they get angry, they riot in the streets.

  • And austerity also doesn't automatically balance a country's budget.

  • You see, the government collects taxes based on people's earnings.

  • So when earnings are reduced, the government collects lesser taxes.

  • They still can't pay down their debts.

  • The pain is so bad that it's almost politically impossible to accomplish.

  • On top of that there are huge cultural differences within the Euro area.

  • Extreme Cultural Differences

  • (More grappa! To the Beach!)

  • (Pay back my money!)

  • Germany is very financially responsible.

  • Ever since the terrible hyper-inflation the country experienced after World War I,

  • it's been extremely inflation averse and incredibly careful about spending and borrowing.

  • In general, Germans work hard, expect little in the line of state benefits and meticulously pay all of their taxes.

  • Many Greeks, on the other hand, enjoy generous state benefits and don't pay taxes.

  • Greece has a terrible problem, it has never collected the majority of the taxes it imposes on its citizens and its always been this way.

  • Joining the Euro just amplified it.

  • The German view is that doesn't work.

  • If you want our money, you need our morals.

  • As the debtor countries headed towards default the whole continent of Europe was in danger.

  • Even though the economies of the debtor countries are relatively small,

  • they posed a huge threat because the European financial system is so interconnected precisely because of the Euro.

  • Remember, the debtor countries borrowed money from banks, investors, and other governments throughout Europe,

  • as the debtor countries get closer to default everyone who lent them money becomes weaker,

  • and everyone who lent those lenders money also becomes weaker, and so on and so forth.

  • A problem in one country could reverberate across the whole continent, triggering a chain-reaction of default.

  • If Greece defaults then Spain could default, Italy, Portugal, and Ireland would be next, then France, then Germany.

  • Pretty soon it could spread not just across Europe but across the world.

  • Fiscal Union or Breakup

  • The problem is even if the debtor nations adopt austerity measures

  • and even if the bailout from Germany and the stronger countries helps them pay down their debts and avoid the immediate crisis,

  • there's no system in place to prevent this from happening again.

  • This brings us back to that fundamental division of monetary policy and fiscal policy.

  • Ultimately, the euro area requires a fiscal union to match its monetary union, or neither.

  • That is, there must be a political organization with authority to set fiscal policy within every Euro area country.

  • It must have the power to cut spending, raise taxes and set laws.

  • A fiscal union like this could actually prevent excessive borrowing and spending.

  • However, this is an enormously complicated and unpopular notion.

  • It means surrendering sovereignty to a higher power, in essence, a United States of Europe.

  • Yet without a centralized fiscal union countries will continue to run deficits, accumulate debt,

  • degrade the value of the euro and threatens stability in Europe.

  • Can Europe take the necessary steps and create a fiscal union alongside the monetary union?

  • Or will the monetary union breakup and the Euro disappear

The European Debt Crisis -- Visualized

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The European Debt Crisis Visualized

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