European sovereign debt crisis

From late 2009, fears of a sovereign debt crisis developed among fiscally conservative investors concerning some European states, with the situation becoming particularly tense in early 2010.[1][2] This includedeurozone members Greece,[3] Ireland, Spain and Portugal and also some EU countries outside the area.[4]Iceland, the country which experienced the largest crisis in 2008 when its entire international banking system collapsed has emerged less affected by the sovereign debt crisis as the government was unable to bail the banks out. In the EU, especially in countries where sovereign debts have increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany.[5][6] While the sovereign debt increases have been most pronounced in only a few eurozone countries they have become a perceived problem for the area as a whole.[7] In May 2011, the crisis resurfaced, concerning mostly the refinancing of Greek public debts. [8] The Greek people generally reject the austerity measures and have expressed their dissatisfaction through angry street protests.[9][10] In late June 2011, the crisis situation was again brought under control with the Greek government managing to pass a package of new austerity measures and EU leaders pledging funds to support the country.[11] Concern about rising government deficits and debt levels[12][13] across the globe together with a wave of downgrading of European government debt[14] created alarm in financial markets. On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth 750 Billion (then almost a trillion dollars) aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF).[15] In 2010 the debt crisis was mostly centered on events in Greece, where the cost of financing government debt was rising. On 2 May 2010, the eurozone countries and the International Monetary Fund agreed to a110 billion loan for Greece, conditional on the implementation of harsh austerity measures.[16] The Greek bail-out was followed by a 85 billion rescue package for Ireland in November,[17] a 78 billion bail-out for Portugal in May 2011,[18][19] then continuing efforts to meet the continuing crisis in Greece and other countries.

This was the first eurozone crisis since its creation in 1999. As Samuel Brittan pointed out,[20] Jason Manolopoulos "shows conclusively that the eurozone is far from an optimum currency area".[21] Niall Ferguson also wrote in 2010 that "the sovereign debt crisis that is unfolding...is a fiscal crisis of the western world".[22]Axel Merk (FT) argued in a May 2011 article that the dollar was in graver danger than the euro.[23]

Eurozone sovereign debt concerns

[edit]Greek

government funding crisis

See also: Economy of Greece 2010-2011 debt crisis [edit]

Greek debt in comparison to Eurozone average

The Greek economy was one of the fastest growing in the eurozone from 2000 to 2007; during that period, it grew at an annual rate of 4.2% as foreign capital flooded the country.[24] A strong economy and falling bond yields allowed the government of Greece to run large structural deficits. According to an editorial published by the Greek right-wing newspaper Kathimerini, large public deficits are one of the features that have marked the Greek social model since the restoration of democracy in 1974. After the removal of the right-wing military junta, the government wanted to bring disenfranchised left-leaning portions of the population into the economic mainstream.[25] In order to do so, successive Greek governments have, among other things, customarily run large deficits to finance public sector jobs, pensions, and other social benefits.[26] Since 1993 debt to GDP has remained above 100%.[27] Initially currency devaluation helped finance the borrowing. After the introduction of the euro in Jan 2001, Greece was initially able to borrow due to the lower interest rates government bonds could command. The late-2000s financial crisisthat began in 2007 had a particularly large effect on Greece. Two of the country's largest industries are tourism and shipping, and both were badly affected by the downturn with revenues falling 15% in 2009. [27] To keep within the monetary union guidelines, the government of Greece had misreported the country's official economic statistics.[28][29] In the beginning of 2010, it was discovered that Greece had paidGoldman Sachs and other banks hundreds of millions of dollars in fees since 2001 for arranging transactions that hid the actual level of borrowing. [30] The purpose of these deals made by several subsequent Greek governments was to enable them to continue spending while hiding the actual deficit from the EU.[31] In 2009, the government of George Papandreou revised its deficit from an estimated 6% (8% if a special tax for building irregularities were not to be applied) to 12.7%. [32] In May 2010, the Greek government deficit was estimated to be 13.6%[33] which is one of the highest in the world relative to GDP.[34] Greek government debt was estimated at 216 billion in January 2010.[35] Accumulated government debt was forecast, according to some estimates, to hit 120% of GDP in 2010.[36] The Greek government bond market relies on

foreign investors, with some estimates suggesting that up to 70% of Greek government bonds are held externally.[37] Estimated tax evasion costs the Greek government over $20 billion per year.[38] Despite the crisis, Greek government bond auctions have all been over-subscribed in 2010 (as of 26 January).[39] According to the Financial Times on 25 January 2010, "Investors placed about 20bn ($28bn, 17bn) in orders for the five-year, fixed-rate bond, four times more than the (Greek) government had reckoned on." In March, again according to the Financial Times, "Athens sold 5bn (4.5bn) in 10-year bonds and received orders for three times that amount."[40] [edit]Downgrading of debt

Interest rate of Greek Two Year Government Bonds traded in the secondary marketreflecting the markets' assesment of investment risk (source: Bloomberg).

On 27 April 2010, the Greek debt rating was decreased to the upper levels of 'junk'[41]status by Standard & Poor's amidst hints of default by the Greek government.[42]Yields on Greek government two-year bonds rose to 15.3% following the downgrading.[43] Some analysts continue to question Greece's ability to refinance its debt. Standard & Poor's estimates that in the event of default investors would fail to get 3050% of their money back.[42] Stock markets worldwide declined in response to this announcement.[44] Following downgradings by Fitch and Moody's, as well as Standard & Poor's, [45]Greek bond yields rose in 2010, both in absolute terms and relative to German government bonds.[46] Yields have risen, particularly in the wake of successive ratings downgrading. According to The Wall Street Journal, "with only a handful of bonds changing hands, the meaning of the bond move isn't so clear."[47] On 3 May 2010, the European Central Bank (ECB) suspended its minimum threshold for Greek debt "until further notice",[48] meaning the bonds will remain eligible as collateral even with junk status. The decision will guarantee Greek banks' access to cheap central bank funding, and analysts said it should also help increase Greek bonds' attractiveness to investors.[49] Following the introduction of these measures the yield on Greek 10-year bonds fell to 8.5%, 550 basis points above German yields, down from 800 basis points earlier.[50] As of 22 September 2011, Greek 10-year bonds were trading at an effective yield of 23.6%, more than double the amount of the year before.[51]

[edit]Austerity and loan agreement On 5 March 2010, the Greek parliament passed the Economy Protection Bill, expected to save 4.8 billion[52] through a number of measures including public sector wage reductions. On 23 April 2010, the Greek government requested that the EU/International Monetary Fund (IMF) bailout package be activated.[53] The IMF had said it was "prepared to move expeditiously on this request".[54] Greece needed money before 19 May, or it would face a debt roll over of $11.3bn.[55][56][57] The European Commission, the IMF and ECB set up a tripartite committee (the Troika) to prepare an appropriate programme of economic policies underlying a massive loan. The Troika was led by Servaas Deroose, from the European Commission, and included also Poul Thomsen (IMF) and Klaus Masuch (ECB) as junior partners. On 2 May 2010, a loan agreement was reached between Greece, the other eurozone countries, and the International Monetary Fund. The deal consisted of an immediate 45 billion in loans to be provided in 2010, with more funds available later. A total of 110 billion has been agreed.[58][59] The interest for the eurozone loans is 5%, considered to be a rather high level for any bailout loan. According to EU officials, France and Germany [60] demanded that their military dealings with Greece be a condition of their participation in the financial rescue.[61] The government of Greece agreed to impose a fourth and final round of austerity measures. These include:[62]

Public sector limit of 1,000 introduced to bi-annual bonus, abolished entirely for those earning over 3,000 a month. An 8% cut on public sector allowances and a 3% pay cut for DEKO (public sector utilities) employees. Limit of 800 per month to 13th and 14th month pension installments; abolished for pensioners receiving over 2,500 a month. Return of a special tax on high pensions. Changes were planned to the laws governing lay-offs and overtime pay. Extraordinary taxes imposed on company profits. Increases in VAT to 23%, 11% and 5.5%. 10% rise in luxury taxes and taxes on alcohol, cigarettes, and fuel. Equalization of men's and women's pension age limits. General pension age has not changed, but a mechanism has been introduced to scale them to life expectancy changes. A financial stability fund has been created.

Average retirement age for public sector workers has increased from 61 to 65. [63] Public-owned companies to be reduced from 6,000 to 2,000.[63]

On 5 May 2010, a nationwide general strike was held in Athens to protest to the planned spending cuts and tax increases. Three people were killed, dozens injured, and 107 arrested.[64] According to research published on 5 May 2010, by Citibank, the European Monetary Union (EMU) loans will be pari passu and not senior like those of the IMF. In fact the seniority of the IMF loans themselves has no legal basis but is respected nonetheless. The loans should cover Greece's funding needs for the next three years (estimated at 30 billion for the rest of 2010 and 40 billion each for 2011 and 2012). Citibank finds the fiscal tightening "unexpectedly tough". It will amount to a total of 30 billion (i.e. 12.5% of 2009 Greek GDP) and consist of 5% of GDP tightening in 2010 and a further 4% tightening in 2011.[65] [edit]Danger of default Further information: Sovereign default Without a bailout agreement, there was a possibility that Greece would prefer to default on some of its debt. The premiums on Greek debt had risen to a level that reflected a high chance of a default or restructuring. Analysts gave a wide range of default probabilities, estimating a 25% to 90% chance of a default or restructuring. [66][67] A default would most likely have taken the form of a restructuring where Greece would pay creditors, which include the up to 110 billion 2010 Greece bailout participants i.e. Eurozone governments and IMF, only a portion of what they were owed, perhaps 50 or 25 percent. [68] It has been claimed that this could destabilise the Euro Interbank Offered Rate, which is backed by government securities.[69] Some experts have nonetheless argued that the best option at this stage for Greece is to engineer an orderly default on Greeces public debt which would allow Athens to withdraw simultaneously from the eurozone and reintroduce a national currency, such as its historical drachma, at a debased rate [70] (essentially, coining money). Economists who favor this approach to solve the Greek debt crisis typically argue that a delay in organising an orderly default would wind up hurting EU lenders and neighboring European countries even more.[71] At the moment, because Greece is a member of the eurozone, it cannot unilaterally stimulate its economy with monetary policy. For example, the U.S. Federal Reserve

expanded its balance sheet by over $1.3 trillion USD since the global financial crisis began, essentially printing new money and injecting it into the system by purchasing outstanding debt.[72] Greece represents only 2.5% of the eurozone economy.[73] Despite its size, the danger is that a default by Greece will cause investors to lose faith in other eurozone countries. This concern is focused on Portugal and Ireland, both of whom have high debt and deficit issues.[74] Italy also has a high debt, but its budget position is better than the European average, and it is not considered among the countries most at risk.[75] Recent rumours raised by speculators about a Spanish bail-out were dismissed by Spanish Prime Minister Jos Luis Rodrguez Zapatero as "complete insanity" and "intolerable".[76] Spain has a comparatively low debt among advanced economies, at only 53% of GDP in 2010, more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or Greece,[77] and it doesn't face a risk of default.[78] Spain and Italy are far larger and more central economies than Greece; both countries have most of their debt controlled internally, and are in a better fiscal situation than Greece and Portugal, making a default unlikely unless the situation gets far more severe.[79] [edit]Objections to proposed policies See also: 20102011 Greek protests The crisis is seen as a justification for imposing fiscal austerity[80] on Greece in exchange for European funding which would lower borrowing costs for the Greek government. [81] The negative impact of tighter fiscal policy could offset the positive impact of lower borrowing costs and social disruption could have a significantly negative impact on investment and growth in the longer term. Joseph Stiglitz has also criticised the EU for being too slow to help Greece, insufficiently supportive of the new government, lacking the will power to set up sufficient "solidarity and stabilisation framework" to support countries experiencing economic difficulty, and too deferential to bond rating agencies.[82] As an alternative to the bailout agreement, Greece could have left the eurozone. Wilhelm Hankel, professor emeritus of economics at the Goethe University Frankfurt suggested[83] in an article published in the Financial Times that the preferred solution to the Greek bond 'crisis' is a Greek exit from the euro followed by a devaluation of the currency. Fiscal austerity or a euro exit is the alternative to accepting differentiated government bond yields within the Euro Area. If Greece remains in the euro while accepting higher bond yields, reflecting its high government deficit, then high interest rates would dampen demand, raise

savings and slow the economy. An improved trade performance and less reliance on foreign capital would be the result.[citation needed] In the documentary Debtocracy made by a group of Greek journalists, it is argued that Greece should create an audit commission, and force bondholders to suffer from losses, like Ecuador did. [edit]Spread

beyond Greece

Public debt as a percent of GDP (2010).

The government surplus or deficit of Portugal, Italy, Ireland, Greece, United Kingdom, and Spain against the eurozone 20002010

Long-term interest rates of selected European countries (secondary market yields of government bonds with maturities of close to ten years).
[84]

Note that weak non-eurozone countries (Hungary, Romania) lack

[85]

the sharp rise in interest rates characteristic of weak eurozone countries. A yield of 6 % or more indicates that financial markets have serious doubts about credit-worthiness.

A graph showing the economic data from Portugal, Italy, Ireland, Greece, United Kingdom, Spain, Germany, the EU and the eurozone for 2009. The data is taken from Eurostat.

One of the central concerns prior to the bailout was that the crisis could spread beyond Greece. The crisis has reduced confidence in other European economies. Ireland, with a government deficit in 2010 of 32.4% of GDP, Spain with 9.2%, and Portugal at 9.1% are most at risk.[86] According to the UK Financial Policy Committee "Market concerns remain over fiscal positions in a number of euro area countries and the potential for contagion to banking systems."[87] Financing needs for the eurozone in 2010 come to a total of 1.6 trillion, while the US is expected to issue US$1.7 trillion more Treasury securities in this period,[88] and Japan has 213 trillion of government bonds to roll over.[89] According to Ferguson similarities between the U.S. and Greece should not be dismissed.[90] For 2010, the OECD forecasts $16,000bn will be raised in government bonds among its 30 member countries. Greece has been the notable example of an industrialised country that has faced difficulties in the markets because of rising debt levels. Even countries such as the US, Germany and the UK, have had fraught moments as investors shunned bond auctions due to concerns about public finances and the economy.[91] [edit]Ireland Main article: 20082011 Irish financial crisis The Irish sovereign debt crisis was not based on government over-spending, but from the state guaranteeing the six main Irish-based banks who had financed a property bubble. On 29 September 2008 the Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to the banks' depositors and bond-holders. He renewed it for another year in September 2009 soon after the launch of the National Asset Management Agency, a body designed to remove bad loans from the six banks. The December 2009 hidden loans controversy within Anglo Irish Bank had led to the resignations of three executives, including chief executive Sen FitzPatrick. A mysterious "Golden Circle" of ten businessmen are being investigated over shares they purchased in Anglo Irish Bank, using loans from the bank, in 2008. The Anglo Irish Bank Corporation Act 2009 was passed to nationalise Anglo Irish Bank was voted throughDil ireann and passed through Seanad ireann without a vote on 20 January 2009.[92] President Mary McAleese then signed the bill at ras an Uachtarin the following day, confirming the bank's nationalisation.[93] In April 2010, following a marked increase in Irish 2-year bond yields, Ireland's NTMA state debt agency said that it had "no major refinancing obligations" in 2010. Its requirement

for 20 billion in 2010 was matched by a 23 billion cash balance, and it remarked: "We're very comfortably circumstanced".[94] On 18 May the NTMA tested the market and sold a 1.5 billion issue that was three times oversubscribed.[95] By September 2010 the banks could not raise finance and the bank guarantee was renewed for a third year. This had a negative impact on Irish government bonds, government help for the banks rose to 32% of GDP, and so the government started negotiations with the ECB and the IMF, resulting in the 85 billion "bailout" agreement of 29 November 2010.[96][97] In February the government lost the ensuing Irish general election, 2011. In April 2011, despite all the measures taken, Moody's downgraded the banks' debt to junk status.[98] Debate continues on whether Ireland will need a "second bailout". [99] [edit]Portugal A report published in January 2011 by the Dirio de Notcias[citation needed] demonstrated that in the period between the Carnation Revolution in 1974 and 2010, the democratic Portuguese Republic governmentshave encouraged over-expenditure and investment bubbles through unclear public-private partnerships and funding of numerous ineffective and unnecessary external consultancy and advisory of committees and firms. This allowed considerable slippage in state-managed public works and inflated top management and head officer bonuses and wages. Persistent and lasting recruitment policies boosted the number of redundant public servants.[citation needed] Risky credit, public debt creation, and European structural and cohesion funds were mismanaged across almost four decades. The Prime Minister Scrates's cabinet was not able to forecast or prevent this in 2005, and later it was incapable of doing anything to improve the situation when the country was on the verge of bankruptcy by 2011.[100] Robert Fishman, in the New York Times article "Portugal's Unnecessary Bailout", points out that Portugal fell victim to successive waves of speculation by pressure from bond traders, rating agencies and speculators.[101] In the first quarter of 2010, before markets pressure, Portugal had one of the best rates of economic recovery in the EU. Industrial orders, exports, entrepreneurial innovation and high-school achievement the country matched or even surpassed its neighbors in Western Europe.[101] On 16 May 2011 the Eurozone leaders officially approved a 78 billion bailout package for Portugal. The bailout loan will be equally split between the European Financial Stabilisation Mechanism, the European Financial Stability Facility, and the International Monetary Fund.[102] According to the Portuguese finance minister, the average interest rate on the bailout loan is expected to be 5.1%[103] As part of the bailout, Portugal agreed to eliminate

its golden share in Portugal Telecom to pave the way for privatization.[104][105]Portugal became the third Eurozone country, after Ireland and Greece, to receive a bailout package. On 6 July 2011 it was confirmed that the ratings agency Moody's had cut Portugal's credit rating to junk status, Moody's also launched speculation that Portugal may follow Greece in requesting a second bailout.[106] [edit]Spain Main article: 20082011 Spanish financial crisis Shortly after the announcement of the EU's new "emergency fund" for eurozone countries in early May 2010, Spain's government announced new austerity measures designed to further reduce the country's budget deficit.[107] The socialist government had hoped to avoid such deep cuts, but weak economic growth as well as domestic and international pressure forced the government to expand on cuts already announced in January. As one of the largest eurozone economies the condition of Spain's economy is of particular concern to international observers, and faced pressure from the United States, the IMF, other European countries and the European Commission to cut its deficit more aggressively.[108][109] According to the Financial Times, Spain has succeeded in trimming its deficit from 11.2% of GDP in 2009 to 9.2% in 2010.[110] It should be noted that Spain's public debt (60.1% of GDP in 2010) is significantly lower than that of Greece (142.8%), Italy (119%), Portugal (93%), Ireland (96.2), and Germany (83.2%), France (81.7%) and the United Kingdom (80.0%).[111][112] [edit]Belgium Main article: 20082009 Belgian financial crisis In 2010, Belgium's public debt was 100% of its GDP the third highest in the eurozone after Greece and Italy[113] and there were doubts about the financial stability of the banks.[114] After inconclusive elections in June 2010, by July 2011[115] the country still had only a caretaker government as parties from the two main language groups in the country (Flemish and Walloon) were unable to reach agreement on how to form a majority government.[113] Financial analysts forecast that Belgium would be the next country to be hit by the financial crisis as Belgium's borrowing costs rose.[114] However the government deficit of 5% was relatively modest and Belgian government 10year bond yields in November 2010 of 3.7% were still below those of Ireland (9.2%), Portugal (7%) and Spain (5.2%).[114] Furthermore, thanks to Belgium's high personal

savings rate, the Belgian Government financed the deficit from mainly domestic savings, making it less prone to fluctuations of international credit markets.[116] [edit]Other

European countries

[edit]United Kingdom According to the Financial Policy Committee "Any associated disruption to bank funding markets could spill over to UK banks."[87] Bank of England governorMervyn King declared that the UK is very much at risk from a domino-fall of defaults and called on banks to build up more capital when financial conditions allowed.[87] The incoming coalition government declared its austerity measures to be essential lest the markets lose confidence in the UK too, that its situation was essentially the same as Portugal's but that it was merely fortunate in having long-dated debt.[citation needed] [edit]Iceland Main article: 20082011 Icelandic financial crisis Iceland suffered the failure of its banking system and a subsequent economic crisis. After a sharp increase in public debts due to the banking failures, the government has been able to reduce the size of deficits each year. The effort has been made more difficult by a more sluggish recovery than earlier expected.[117]Before the crash of the three largest commercial banks in Iceland, Glitnir, Landsbanki and Kaupthing, they jointly owed over 10 times Iceland's GDP. In October 2008, the Icelandic parliament passed emergency legislation to minimise the impact of the financial crisis. The Financial Supervisory Authority of Iceland used permission granted by the emergency legislation to take over the domestic operations of the three largest banks.[118] The foreign operations of the banks, however, went into receivership. As a result, the country has not been seriously affected by the European sovereign debt crisis from 2010. In large part this is due to the success of an IMF Stand-By Arrangement in the country since November 2008. The government has enacted a program of medium term fiscal consolidation, based on expenditure cuts and broad based and significant tax hikes. As a result, central government debts have been stabilised at around 80-90 percent of GDP.[119] Capital controls were also enacted and the work began to resurrect a sharply downsized domestic banking system on the ruins of its gargantuan international banking system, which the government was unable to bail out.[120][121] Despite a contentious debate with Britain and the Netherlands over the question of a state guarantee on the Icesave deposits of Landsbanki in these countries,credit default swaps on

Icelandic sovereign debt have steadily declined from over 1000 points prior to the crash in 2008 to around 200 points in June 2011. Further, on 9 June 2011, the Icelandic government successfully raised 1$ billion with a bond issue indicating that international investors are viewing positively the efforts of the government to consolidate the public finances and restructure the banking system, with two of the three biggest banks now in foreign hands.[120][121] [edit]Switzerland In September 2011, the Swiss National Bank weakened the Swiss franc to a floor of 1.20[122] francs per euro. The franc has been appreciating against the euro during to the crisis, harming Swiss exporters. The SNB surprised currency traders by pledging that "it will no longer tolerate a euro-franc exchange rate below the minimum rate of 1.20 francs." This is the biggest Swiss intervention since 1978. [edit]Solutions [edit]EU

emergency measures

On 9 May 2010, the 27 member states of the European Union agreed to create the EFSF, a legal instrument[123] aiming at preserving financial stability in Europe by providing financial assistance to eurozone states in difficulty. The facility is jointly and severally guaranteed by the Eurozone countries' governments.[124] In order to reach these goals the Facility is devised in the form of a special purpose vehicle (SPV) that will sell bonds and use the money it raises to make loans up to a maximum of 440 billion to eurozone nations in need. The new entity will sell debt only after an aid request is made by a country.[125] The EFSF loans would complement loans backed by the lender of last resort International Monetary Fund, and in selected cases loans by the European Financial Stabilisation Mechanism. The total safety net available would be therefore 750 billion, consisting of up to 440 billion from EFSF, up to 60 billion loan from the European Financial Stabilisation Mechanism (reliant on guarantees given by the European Commission using the EU budget as collateral) and 250 billion loan backed by the IMF.[126][127] The agreement is interpreted to allow the ECB to start buying government debt from the secondary market which is expected to reduce bondyields.[128] (Greek bond yields fell from over 10% to just over 5%;[129] Asian bonds yields also fell with the EU bailout.[130])

The ECB has announced a series measures aimed at reducing volatility in the financial markets and at improving liquidity:[131]

First, it began open market operations buying government and private debt securities. Second, it announced two 3-month and one 6-month full allotment of Long Term Refinancing Operations (LTRO's). Thirdly, it reactivated the dollar swap lines[132] with Federal Reserve support.[133]

Subsequently, the member banks of the European System of Central Banks started buying government debt.[134] Stocks worldwide surged after this announcement as fears that the Greek debt crisis would spread subsided,[135] some rose the most in a year or more.[136] The Euro made its biggest gain in 18 months,[137] before falling to a new four-year low a week later.[138] Commodity prices also rose following the announcement.[139]The dollar Libor held at a nine-month high.[140] Default swaps also fell.[141] The VIX closed down a record almost 30%, after a record weekly rise the preceding week that prompted the bailout. [142] Despite the moves by the EU, the European Commissioner for Economic and Financial Affairs, Olli Rehn, called for "absolutely necessary" deficit cuts by the heavily indebted countries of Spain and Portugal.[143] Private sector bankers and economists also warned that the threat from a double dip recession has not faded. Stephen Roach, chairman of Morgan Stanley Asia, warned about this threat saying "When you have a vulnerable postcrisis economic recovery and crises reverberating in the aftermath of that, you have some very serious risks to the global business cycle."[144] Nouriel Roubini said the new credit available to the heavily indebted countries did not equate to an immediate revival of economic fortunes: "While money is available now on the table, all this money is conditional on all these countries doing fiscal adjustment and structural reform."[145] After initially falling to a four-year low early in the week following the announcement of the EU guarantee packages, the euro rose as hedge funds and other short-term traders unwound short positions and carry trades in the currency.[146] While the aid package has so far averted a financial panic, international credit rating agencies consider that eurozone countries such as Portugal continue to have economic difficulties.[147] In July 2011, it was agreed during the EU summit Greece should receive EU loans at lower interest rates of 3.5%.[148]

In September, 2011, Jrgen Stark became the second German after Axel A. Weber to resign from the ECB Governing Council in 2011. Weber, the former Deutsche Bundesbank president, was once thought to be a likely successor to Jean-Claude Trichet as bank president. He and Stark were both thought to have resigned due to "unhappiness with the ECBs bond purchases, which critics say erode the banks independence". Stark was "probably the most hawkish" member of the council when he resigned. Weber was replaced by his Bundesbank successor Jens Weidmann and "[l]eaders in Berlin plan to push for a German successor to Stark as well, news reports said".[149] Later in the month, on the eve of an important parliamentary test in Germany, British commentator David Marsh saw Weidman taking a "cool" course relative to German chancellor Angela Merkel, to whom he had previously been economic adviser. Marsh saw Weidmann leaning toward the "EMU remain[ing] a looser grouping of countries" than currently, not toward Merkel's so-far stated goal of maintaining the Euro and the EMU in their current forms.[150] In the event, the Bundestag voted 523 to 85 to approve the increase in the EFSF's available funds to 440bn (Germany's share 211bn), a victory for Merkel, though other possible ways to expand the EFSF and EMU powers were not addressed in the legislation. Wolfgang Schuble, the German finance minister, and Philipp Rsler, the economics minister, were concurrently on record against leveraging the EFSF. With Germany's vote, Slovakia[151] and the Netherlands remained to vote on the expansion package.[152] In early October, Slovakia remained uncertain as to the approval, with "political turmoil in Bratislava, the nations capital, exposing strains within the four-party ruling coalition".[153] [edit]Kicking

the can

See also: Euro Plus Pact European Union leaders have made two major proposals for ensuring fiscal stability in the long term. The first proposal is the creation of the European Financial Stability Facility.[154] The second is a single authority responsible for tax policy oversight and government spending coordination of EU member countries, temporarily called the European Treasury.[155] The stability facility is financially backed by the EU and the IMF. The European Parliament, the European Council, and especially the European Commission, can all provide some support for the treasury while it is still being built. However, strong European Commission oversight in the fields of taxation and budgetary policy and the enforcement mechanisms that go with it have sometimes been described as potential infringements on the sovereignty of eurozone member states.[156]

Some senior German policy makers went as far as to say that emergency bailouts should bring harsh penalties to EU aid recipients such as Greece.[157] Others argue that an abrupt return to "non-Keynesian" financial policies is not a viable solution and predict the deflationary policies now being imposed on countries such as Greece and Italy might prolong and deepen their recessions.[70][158] The Economist has suggested that ultimately the Greek "social contract," which involves "buying" social peace through public sector jobs, pensions, and other social benefits, will have to be changed to one predicated more on price stability and government restraint if the euro is to survive.[159] As Greece can no longer devalue its way out of economic difficulties it will have to more tightly control spending than it has since the inception of the Third Hellenic Republic. Regardless of the corrective measures chosen to solve the current predicament, as long as cross border capital flows remain unregulated in the Euro Area,[160]asset bubbles[161] and current account imbalances are likely to continue. For example, a country that runs a large current account or trade deficit (i.e., it imports more than it exports) must also be a net importer of capital; this is a mathematical identity called the balance of payments. In other words, a country that imports more than it exports must also borrow to pay for those imports. Conversely, Germany's large trade surplus (net export position) means that it must also be a net exporter of capital, lending money to other countries to allow them to buy German goods.[162] The 2009 trade deficits for Italy, Spain, Greece, and Portugal were estimated to be $42.96 billion, $75.31B and $35.97B, and $25.6B respectively, while Germany's trade surplus was $188.6B.[163] A similar imbalance exists in the U.S., which runs a large trade deficit (net import position) and therefore is a net borrower of capital from abroad. Ben Bernanke warned of the risks of such imbalances in 2005, arguing that a "savings glut" in one country with a trade surplus can drive capital into other countries with trade deficits, artificially lowering interest rates and creating asset bubbles.[164][165] A country with a large trade surplus would generally see the value of its currency appreciate relative to other currencies, which would reduce the imbalance as the relative price of its exports increases. This currency appreciation occurs as the importing country sells its currency to buy the exporting country's currency used to purchase the goods. However, many of the countries involved in the crisis are on the Euro, so this is not an available solution at present. Alternatively, trade imbalances might be addressed by changing consumption and savings habits. For example, if a country's citizens saved more instead of consuming imports, this would reduce its trade deficit.[166]

Likewise, reducing budget deficits is another method of raising a country's level of saving. Capital controls that restrict or penalize the flow of capital across borders is another method that can reduce trade imbalances. Interest rates can also be raised to encourage domestic saving, although this benefit is offset by slowing down an economy and increasing government interest payments.[167] The suggestion has been made that long term stability in the eurozone requires a common fiscal policy rather than controls on portfolio investment.[168] In exchange for cheaper funding from the EU, Greece and other countries, in addition to having already lost control over monetary policy and foreign exchange policy since the euro came into being, would therefore also lose control over domestic fiscal policy. Finally, there has been some criticism over the austerity measures implemented by most European nations to counter this debt crisis. Apart from arguments over whether or not austerity, rather than increased or frozen spending, is a macroeconomic solution, there has also been a sense of unjust crisis management which mostly stems from the notion that, as a direct consequence of the financial crisis, the working population should not be held responsible for the economic mismanagement errors of economists, investors, and bankers. Over 23 million EU workers have become unemployed as a consequence of the global economic crisis of 20072010, while thousands of bankers across the EU have become millionaires despite collapse or nationalization (ultimately paid for by taxpayers) of institutions they worked for during the crisis, a fact that has led many to call for additional regulation of the banking sector across not only Europe, but the entire world.[169] [edit]

Reform and recovery

In November, as concerns started to resurface about the fiscal health of Ireland, Greece and Portugal, EU President Herman Van Rompuy said "If we dont survive with the eurozone we will not survive with the European Union."[170] In March 2011 a new reform of the Stability and Growth Pact was initiated, aiming at straightening the rules by adopting an automatic procedure for imposing of penalties in case of breaches of either the deficit or the debt rules.[171][172] Subsequently, the proposed European treasury was implemented as the temporary European Financial Stability Facility, which will function until the permanentEuropean Stability Mechanism is established following ratification of its treaty. In July 2011, it was agreed during the EU summit that the EFSF will be given more powers to

intervene in the secondary markets, thus dramatically socializing risk in the eurozone, which ends the crisis.[173] [edit]Two-currencies

speculation

Bloomberg has suggested that, if the Greek and Irish bailouts should fail, an alternative is for Germany to leave the eurozone in order to save the currency throughdepreciation[174] instead of austerity. The Wall Street Journal conjectures that Germany could return to the Deutsche Mark,[175] or create another currency union[176] with the Netherlands, Austria, Finland, Luxembourg and other European countries that have a positive current account balance, such as Denmark, Norway, Sweden, Switzerland and the Baltics.[177] A monetary union of the mentioned current account surplus countries would create the world's largest creditor bloc that is bigger than China[178] or Japan. Without the German-led bloc, The Wall Street Journal and other writers suggest, a residual French-led euro will then have the flexibility to keep interest rates[179]low and engage in quantitative easing[180] or fiscal stimulus in support of a job-targeting economic policy[181] instead of inflation targeting in the current configuration. The German-led bloc can lawfully exit the eurozone, by simply breaking the Maastricht criteria for membership, for example the three percent deficit to GDP rule, or by negotiating an exit with the rest of the eurozone if there is a failure of any of the bailouts. The French-led euro bloc is expected to grow its combined current account deficits, comparable to the United States, increasing its usage overseas and improving its status as reserve currency. A monetary union of all the remaining current account deficit countries would create the world's second largest deficit bloc, second only to the United States, the owner of the world's primary reserve currency. In order to reduce the dollar's Triffin dilemma and become a more influential currency union, the eurozone must do the following. First, let the German-led bloc exit the eurozone orderly. Second, give up the stability mandate copied from the Bundesbank, in order to purchase government debts[182] of Greece, Italy, and the other indebted countries. Third, import more goods and export more of the currency overseas. And fourth, build economic governance and fiscal union in the leftover eurozone. The German-led bloc will be less inflationary than the euro, but it will not be as widely used internationally as the euro. This two-currency system can benefit all of Europe, dependent on the political or economic goals of each EU member state, that is stability versus international usage.[citation needed] In September 2011, Joaqun Almunia, an EU commissioner, lashed out[183] against the bloc of Germany, Netherlands, Finland, Austria. When asked about the possibility of a return of the deutsche mark, ECB president Jean-Claude Trichet also lost his cool[184] and defended

the price stability of the euro in a six minutes long response. In October 2011, policy expert Philippa Malmgren believed[185] that "the Germans will announce they are reintroducing the Deutschmark" in the coming weeks. When asked if the eurozone will split apart, former Federal Reserve chairman Alan Greenspan answered cautiously, "If you ask me starting from scratch, would they have been better off having a eurozone which included Germany, Austria, Luxembourg, Finland, the Netherlands, that would have worked."[186]Greenspan later added Switzerland in the list. [edit]Heterodox

recommendations

The school of economists who are, broadly, adherents of the post-Keynesian school of the Modern Monetary Theory have condemned the introduction of the Eurocurrency from the beginning,[187] on the basis that the Eurozone does not fulfill the necessary criteria for an optimum currency area. The latter view is supported also by non-Keynesian economists, such as Luca A. Ricci, of the IMF.[188] Others have even declared an urgent need for more radical shift in perspective, "a new science of macroeconomics".[189] As the debt crisis expanded beyond Greece, these economists continued to advocate, albeit more forcefully, the disbandment of the Eurozone. If this is not immediately feasible, they recommended that Greece and the other debtor nations unilaterally leave the Eurozone, default on their debts, regain their fiscal sovereignty, and re-adopt national currencies.[190][191] Others have suggested that it's Germany that should first leave the Eurozone in order to save it,[192] with an anticipated "huge boost" to its members' competitiveness via the "(likely) substantial fall in the Euro against the newly reconstituted Deutsche Mark". [edit]Controversies [edit]Breaking

of the EU treaties

The Maastricht Treaty of EU contains juridical language which appears to rule out intra-EU bailouts. First, the no bail-out clause (Article 125 TFEU) ensures that the responsibility for repaying public debt remains national and prevents risk premiums caused by unsound fiscal policies from spilling over to partner countries. The clause thus encourages prudent fiscal policies at the national level. The European Central Bank purchase of distressed country bonds can be viewed to break the prohibition of monetary financing of budget deficits (Article 123 TFEU). The creation of further leverage in EFSF with access to ECB lending would also appear to break this Article.

The Articles 125 and 123 were meant to create disincentive for EU member states to run excessive deficits and state debt, and prevent the moral hazard of over-spend and lending in good times. They were also meant to protect the taxpayers of the other more prudent member states. By issuing bail out aid guaranteed by the prudent Eurozone taxpayers to rule-breaking Eurozone countries such as Greece, the EU and Eurozone countries encourage moral hazard also in the future.[193] [edit]Odious

debt

Some protesters, commentators such as Libration correspondent Jean Quatremer and the Lige based NGO Committee for the Abolition of the Third World Debt(CADTM) allege that the debt should be characterized as odious debt.[194] The Greek documentary Debtocracy examines whether the recent Siemens scandal and uncommercial ECB loans which were conditional on the purchase of military aircraft and submarines are evidence that the loans amount to odious debt and that an audit would result in invalidation of a large amount of the debt. [edit]Controversy

about national statistics

The revision of Greeces 2009 budget deficit from a forecast of "6-8% of GDP" to 12.7% by the new Pasok Government in late 2009 (a number which, after reclassification of expenses under IMF/EU supervision was further raised to 15.4% in 2010) has been cited as one of the issues that ignited the Greek debt crisis. This added a new dimension in the world financial turmoil, as the issues of "creative accounting" and manipulation of statistics by several nations came into focus, potentially undermining investor confidence. The focus has naturally remained on Greece due to its debt crisis, however there has been a growing number of reports about manipulated statistics by EU and other nations aiming, as was the case for Greece, to mask the sizes of public debts and deficits. These have included analyses of examples in several countries[195] [196] [197] [198] or have focused on Italy, [199] the United Kingdom, [200] [201] [202] [203] [204] [205] [206] [207] Spain, [208] the United States, [209] [210] [211] and even Germany. [212] [213] [edit]Credit

rating agencies

The international U.S. based credit rating agencies Moody's, Standard & Poor's and Fitch have played a central[214] and controversial role[215] in the current European bond market crisis.[216] As with the housing bubble[217][218] and the Icelandic crisis,[219][220] the ratings agencies have been under fire. The agencies have been accused

of giving overly generous ratings due to conflicts of interest.[221] Ratings agencies also have a tendency to act conservatively, and to take some time to adjust when a firm or country is in trouble.[222] In the case of Greece, the market responded to the crisis before the downgrades, with Greek bonds trading at junk levels several weeks before the ratings agencies began to describe them as such.[214] In a response to the downgrading of Greek governmental bonds the ECB announced on 3 May that it will accept as collateral all outstanding and new debt instruments issued or guaranteed by the Greek government, regardless of the nation's credit rating.[223] Government officials have criticized the ratings agencies. Following downgrades of Greece, Spain and Portugal that roiled financial markets, Germany's foreign minister Guido Westerwelle said that traders should not take global rating agencies "too seriously" and called for an "independent" European rating agency, which could avoid the conflicts of interest that he claimed US-based agencies faced.[214][224] European leaders are reportedly studying the possibility of setting up a European ratings agency in order that the private U.S.-based ratings agencies have less influence on developments in European financial markets in the future.[225][226] According to German consultant company Roland Berger, setting up a new ratings agency would cost 300 million Euros and could be operating by 2014.[227] Due to the failures of the ratings agencies, European regulators will be given new powers to supervise ratings agencies.[215] With the creation of the European Supervisory Authority in January 2011 the European Union set up a whole range of new financial regulatory institutions,[228] including the European Securities and Markets Authority (ESMA),[229] which will become the EUs single credit-ratings firm regulator on 7 July.[230] Credit-ratings companies have to comply with the new standards or be denied operation on EU territory, says ESMA Chief Steven Maijoor.[231] But attempts to regulate more strictly credit rating agencies in the wake of the European sovereign debt crisis have been rather unsuccessful. Some European financial law and regulation experts have argued that the hastily drafted, unevenly transposed in national law, and poorly enforced EU rule on rating agencies (Rglement CE n 1060/2009) has had little effect on the way financial analysts and economists interpret data or on the potential for conflicts of interests created by the complex contractual arrangements between credit rating agencies and their clients" [232]

[edit]Media There has been considerable controversy about the role of the English-language press in the regard to the bond market crisis.[233][234] The Spanish Prime MinisterJos Luis Rodrguez Zapatero has suggested that the recent financial market crisis in Europe is an attempt to draw international capital away from the euro[235][236]in order that countries, such as the U.K. and the U.S., can continue to fund their large external deficits which are matched by large government deficits.[12] The U.S. and U.K. do not have large domestic savings pools to draw on and therefore are dependent on external savings.[237] This is not the case in the eurozone which is self funding.[238] Zapatero ordered the Centro Nacional de Inteligencia intelligence service (National Intelligence Center, CNI in Spanish) to investigate the role of the "Anglo-Saxon media" in fomenting the crisis.[239][240][241][242][243][244][245] No results have so far been reported from this investigation. Greek Prime Minister Papandreou is quoted as saying that there was no question of Greece leaving the euro and suggested that the crisis was politically as well as financially motivated. "This is an attack on the eurozone by certain other interests, political or financial".[246] At the same time, a statistic on the articles referenced here shows that only "bad" news was propagated by the media and never "good" news. [edit]Role

of speculators

Financial speculators and hedge funds engaged in selling euros have also been accused by both the Spanish and Greek Prime Ministers of worsening the crisis.[247][248] German chancellor Merkel has stated that "institutions bailed out with public funds are exploiting the budget crisis in Greece and elsewhere."[249] The role of Goldman Sachs[250] in Greek bond yield increases is also under scrutiny.[251] It is not yet clear to what extent this bank has been involved in the unfolding of the crisis or if they have made a profit as a result of the sell-off on the Greek government debt market. In response to accusations that speculators were worsening the problem, some markets banned naked short selling for a few months.[252] [edit]Finland

collateral

On August 18, 2011, as requested by the Finnish parliament as a condition for any further bailouts, it became apparent that Finland would receive collateral from Greece enabling it to participate in the potential new 109 billion support package for the Greek economy.[253] Austria, the Netherlands, Slovenia, and Slovakia responded with irritation over this special guarantee for Finland and demanded equal treatment across the Eurozone, or a

similar deal with Greece, as not to increase the risk level over their participation in the bailout.[254] The main point of contention was that the collateral is aimed to be a cash deposit, a collateral the Greeks can only give by recycling part of the funds loaned by Finland for the bailout, which means Finland and the other Eurozone countries guarantee the Finnish loans in the event of a Greek default.[255][256] After extensive negotiations to implement a collateral structure open to all Eurozone countries, on 4 October 2011, a modified escrow collateral agreement was reached. The expectation is that only Finland will utilise it, due to i.a. requirement to contribute initial capital to European Stability Mechanism in one installment instead of five installments over time. Finland, as one of the strongest AAA countries, can raise the required capital with relative ease.[257] At the beginning of October, Slovakia and Netherlands were the last countries to vote on the ESFS expansion, which was the immediate issue behind the collateral discussion, with a mid-October vote.[151][152] However, as of October 10, Slovakia's government was still deeply split over the issue.[153]