The Eurozone Crisis Explained in Brief

As the eurozone debt crisis heats up to volcanic temperatures and the rumor mill accelerates toward warp speed I thought it would be appropriate to remind ourselves what exactly the problem is and why it is a difficult one to fix overnight:

What are the causes of the sovereign debt crisis in the Eurozone?

  • Too much debt- from the individual member states to the over leveraged financial institutions
  • Uncompetitive and vastly different economies tied to one ‘too strong’ currency
  • Lack of a single fiscal authority within the Eurozone capable of strict supervision/enforcement- anything short of full police powers is laughable and not even worth considering.

What are the resulting problems?

  • Higher interest rates on sovereign debt of heavily indebted countries which only exacerbates the crisis. Akin to placing more weight on top of a lame donkey as it climbs uphill.
  • Fiscal austerity measures which only make the necessary economic growth much harder to achieve i.e. Greece ( the poster boy for the failure of fiscal austerity)
  • Debt contagion crisis which will likely result from placing “haircuts” on sovereign debt
  • Market turmoil which has boiled over into the banking sector, thereby creating bank runs and market seizures which leads to national governments being forced to guarantee their banking sectors~~~> leading to more debt being heaped upon the sovereign ~~~> rating agency downgrades and higher interest rates over the sovereign debt issuance. In summary a vicious cycle of debt and instability which is absolutely unsustainable longer term.

Challenges to solving the crisis:

  • 17 headed Eurozone hydra, each one bargaining and positioning in their own individual best interest with no clear overall objective.
  • Debt must be either paid off, forgiven, or inflated away. Which one will the Eurozone choose? If it is to be paid off then someone will have to pay a very large tab, who will it be? Germany is very much against a euro fiscal transfer union. Forgiven? Then bondholders take huge losses and the Eurozone sets a new and dangerous precedent of allowing sovereign defaults~~~> very dangerous and uncharted waters for financial markets. Inflate the debt away? Only the central bank can do this and the ECB has made it very clear that this option is completely off the table. However, I believe large scale ECB involvement to be the most likely eventual outcome- the question is when and how?
  • Rewriting the EU treaties of each sovereign allowing for the creation of a Eurozone treasury with police enforcement powers which requires each member state to relinquish their sovereignty to Brussels<~~~~~This is nothing short of a Herculean task which will take YEARS! I am HIGHLY skeptical that a single euro treasury with sweeping supervisory & enforcement powers will ever be achieved.      
Further Reading- Another bombshell from Der Spiegel this morning – Merkel’s hands are tied as she now must seek approval from the Bundestag before agreeing to any new rescue plans while other eurozone members are absolutely furious at Germany’s delays: “German Parliament Slows Euro Rescue Decisions”

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