Saturday, August 20, 2011

What is happening in Europe: A primer

Here is a quick primer on what is actually troubling Europe. I wrote it to explain the situation to myself, and, share it with readers.

A. It is th EU - European Union
Most of Europe is part of the European Union, which has a common currency - the EURO. We are talking about the EU. Now, by joining the EU, countries have given up their right to manage their own currencies. In India, if the Govt faces a deficit, it can take loans from the reserve bank, print money or devalue its currency, to cover the deficit. But, EU countries cannot do so, since they do not have their own currencies any more.

B. So they take loans
In the good times till 2008, Ireland, Spain, Portugal and Greece had booming economic conditions, together with the rest of the world. Big spending plans were made, with a lot of money going to different sections of society. Their budgets were in deficits. To finance these deficits, the countries borrowed money from banks, mainly European(German and French) banks. A lot of this money was used in spending, for example in subsidies and such. Then came the 2009 slow down which has continued till date. Revenues fell, while spending remained the same. Soon, banks became reluctant to give more money.

C. How will the banks be repaid?
That's the big issue. Actually, countries need to borrow continuously to pay previous loans and continue spending. Once the country cannot borrow, they cannot pay the loans already taken. Fortunately, for the Greeks that is, most of the money was borrowed from French, german and british banks, so it is these countries who are worried about the PIGS. (Portugal, Ireland, Greece, Spain).

D. What is the solution?
There are no easy ways. The rich countries of Europe insist that the PIGS balance their budgets by incresing taxes and reducing spending. Then only will the rich give money to the PIGS. This money will be used to repay the banks which belong to the rich countries. But, then, instead of the bank, the rich country will become the lender. So what is the difference? Not much. German citizens are not happy at the idea of their money being given out this way.

I have given a simplified version of the issues facing Europe. The point seems to be: there are no easy solutions to the mess. Reader comments and their views are welcome.


anshul said...

thanks for explaining things in simple language..useful post

Shazia said...

It looks like a spiral downwards!!
Think support systems didn't help much after all.. it never does in the long run in any case.
Increasing taxes and lowering spending.. how can this help in repaying? lowering spending can only mean doom for any economy!!

Balu said...


I think the major reason for this difficult situation is - most of the countries spending the borrowed money on non productive things and unnecessary more than required luxuries... now that the damage has already been done, before finding a way out it would be better if one assumes a similar crisis in a small family. Only thing one can do then is work harder, generate more income, cut down spending and over a period of time get free of debt.
So similar action is required by European countries, may be in more different ways but objective should be same. There can't be any other way.

In general in such a situation mergers or takeovers happen in case of business organisations. It may not be a possibility here.

A big disadvantage is they don't have individual currency of their own. Is there any possibility of disuniting from the union and introduce their own currency and start borrowing from other financially sound nations in case Germany is not willing to lend anymore?

All may not be over for those countries with this crisis. They may be getting financial aid from some quarter of the world and survive temporarily, but can only sustain with underlying ability and true skill(in case of a nation or any individual).

Great leaders are required by any nation during such critical phases.

Sasi Uppuluri said...

Sir, as you said in your conclusion, looks like there is no easy solution to this mess.

My opinion of what could happen is:

It's just a matter of time that Greece would default and other nations in PIIGS would follow. If the situation worsens, the rich countries like Germany and France would not be able to support these PIIGS because they would have political problems from voters as it is tax payers money from the rich countries in the EU. So, the rich in the EU might allow the euro zone to fall instead of shouldering small countries, thus creating banking crisis in Europe and in this interconnected world economy, every country is going to face the heat. And with US having it's own debt problems, we can consider recession all but inevitable.

Whatever the scenario that might develop, for traders we can expect some volatility, some black swan events and it's time for all to read your previous blog post - "How to survive a bear market"

Sasi Uppuluri said...