ft project vi term

8/2/2019 FT Project VI Term

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SRI SHARADA INSTITUTE OF INDIAN MANAGEMENT-RESEARCH

(A unit of Sri Sringeri Sharada Peetham, Sringeri)

Approved by AICTE

Plot No. 7, Phase-II, Institutional Area, Behind the Grand Hotel, Vasant Kunj,

New Delhi 110070 Tel.: 2612409090 / 91; Fax: 26124092

E-mail: [email protected]; Website: www.srisim.org

Project Report

On

THE CAUSES OF EUROPEAN UNION FINANCIAL CRISIS

SUBMITTED TO :- SUBMITTED BY:-

Prof Dr. Ritvik Dubey Shruti Kumari(20100146)

Sharmistha Purkayastha(20100145)PGDM-2nd Year


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ACKNOWLEDGEMENT

I take immense pleasure in thanking Our Rev. Swamiji for having permitted me to

carry out this project work.I wish to express my deep sense of gratitude to my Guide, Prof (Dr.)Ritvik

Dubey, Sri Sharada Institute of Indian Management-Research, for him able

guidance and useful suggestions, which helped me in completing the project work,

in time.

Finally, yet importantly, I would like to express my heartfelt thanks to my

beloved parents for their blessings, my friends/classmates for their help and wishesfor the successful completion of this project.

Shruti Kumari

Sharmistha Purkayastha


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DECLARATION

We, herby declared to the best of my knowledge and belief that the project reportentitled as for The Causes Of European Union Financial Crisis being submittedto the partial fulfillment of SRI SHARADA INSTITUTE OF INDIANMANAGEMENT AND RESEARCH, has not substantially the same one, whichhas already been submitted for Post Graduate Diploma in Management of anyother academic qualification at any other university or examination in India.

(Shruti Kumari)

(Sharmistha Purkayastha)


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TERMINOLOGIES

Austerity Measures: An official action taken by the government in order to reduce the amount

of money that it spends or the amount that people spend sometimes coupled with increases

in taxes to pay back creditors to reduce debt.

Bailout: A bailout is an act of loaning or giving capital to an entity (a company, a country, or an

individual) that is in danger of failing, in an attempt to save it from bankruptcy, insolvency, or

total liquidation and ruin; or to allow a failing entity to fail gracefully without spreading

contagion.

Financial Contagion: A situation in which a faltering economy in one country causes otherwisehealthy economies in other countries to have problems. Financial contagion often becomes a

large problem for the direct or regional neighbors of the troubled economy.

Sovereign Debt: A government bond is a bond issued by a national government. Such bonds are

often denominated in the country's domestic currency. Bonds issued by national governments in

foreign currencies are normally referred to as sovereign bonds.


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INTRODUCTION

A period of time in which several European countries faced the collapse of financial institutions,high government debt and rapidly rising bond yield spreads in government securities. The

European sovereign debt crisis started in 2008, with the collapse of Iceland's banking system,and spread primarily to Greece, Ireland and Portugal during 2009. The debt crisis led to a crisisof confidence for European businesses and economies

From late 2009, fears of a sovereign debt crisis developed among fiscally conservative investorsconcerning some European states, with the situation becoming particularly tense in early2010. This included euro zone members Greece, Ireland and Portugal and alsosome EU countries outside the area. Iceland, the country which experienced the largest crisis in2008 when its entire international banking system collapsed has emerged less affected by thesovereign 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 ofconfidence has emerged with the widening of bond yield spreads and risk insurance on creditdefault swaps between these countries and other EU members, most importantly Germany.

A government bond is a bond issued by a national government. Such bonds are often

denominated in the country's domestic currency. Bonds issued by national governments in

foreign currencies are normally referred to as sovereign bonds. Government bonds are

sometimes regarded as risk-free bonds, because national governments can raise taxes or reduce

spending up to a certain point; in many cases they "print more money" to redeem the bond at

maturity. (Some governments are not currently entitled to print money directly, but only througha Central bank at interest. Investors in sovereign bonds denominated in foreign currency have the

additional risk that the issuer may be unable to obtain foreign currency to redeem the bonds.

While the sovereign debt increases have been most pronounced in only a few euro zone countries

they have become a perceived problem for the area as a whole. In May 2011, the crisis

resurfaced, concerning mostly the refinancing of Greek public debts. The Greek people generally

reject the austerity measures and have expressed their dissatisfaction through angry street

protests. 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.

Concern about rising government deficits and debt levels across the globe together with a wave

of downgrading of European government debt created alarm in financial markets. On 9 May

2010, Europe's Finance Ministers approved a comprehensive rescue package worth 750 Billion


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(then almost a trillion dollars) aimed at ensuring financial stability across Europe by creating

the European Financial Stability Facility (EFSF).

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. The Greek bail-out was followed by a 85 billion rescue package for

Ireland in November, and a 78 billion bail-out for Portugal in May 2011.

This was the first Eurozone crisis since its creation in 1999. As Samuel Brittan pointed out, Jason

Manolopoulos "shows conclusively that the Eurozone is far from an optimum currency area".

Niall Ferguson also wrote in 2010 that "the sovereign debt crisis that is unfolding...is a fiscal

crisis of the western world". Axel Merk (FT) argued in a May 2011 article that the dollar was in

grave danger than the euro.

The European sovereign debt crisis was brought to heel by the financial guarantees by Europeancountries, who feared the collapse of the euro and financial contagion, and by the InternationalMonetary Fund (IMF). Ratings agencies downgraded the debt of several Eurozone countries,with Greek debt at one point being moved to junk status. As part of the loan agreements,countries receiving bailout funds were required to meet austerity measures designed to slowdown the growth of public sector debt.

Countries Involved

The following countries of European Union (EU) were involved in the Sovereign Crisis of theEuro Zone:-

Greece Ireland Portugal Spain Italy Belgium

And many other European countries like UK, Iceland and Switzerland.


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CAUSE OF THE CRISIS

While everyone is focusing on the so-called obvious factors, they have missed the mostimportant factor; the real reason behind the crisis. The crisis started in Greece and the top EUmembers knew they were going to bail out Greece and potentially any other member that neededhelp, but they pretended that they would not. One of the obvious reasons for the bailout was notto protect Greece, but to save the bond holders; most of the bond holders are foreigners. Thatsthe same reason the banks were bailed out in the US, to protect the large shareholders ; its all agame of smoke and mirrors. That is the cause of this crisis.

Our hypothesis is that the main reason that the Euro crisis was allowed to evolve was to deflatethe Euro. Note that we have stated many times in the past that we have now entered into thecompetitive currency devaluation era, where the theme is or will soon be devalue or die. Or

maybe we should add devalue or die trying to, for nations are going to do whatever it takes to

keep their products competitive in the global market.

Germany was knocked out of the top place and replacedby China as the worlds largest exporterand that must have hurt. Thus by allowing the crisis to progress, the EU could, in fact, devaluethe Euro without actually issuing new currency. And then when things started to look really bad,they could pretend to help by approving a huge package, but this package would now devalue theeuro even more. Thus with one stone they killed two birds in the sense that it produced doublethe effect. If they had approved a bailout package immediately, the euro would not have shed asmuch as it did. In a matter of months the Euro dropped almost 24%; in the currency markets, thisis considered to be a very large move.

Another factor to consider is that no government wants to pay its debt in a stronger currency;

governments borrow money so that they can pay it back with cheap currency.

Thus while one currency might appear to be appreciating against another; the truth is that theyare all falling down, some faster than others. Take a look at some long term commodity charts,and you will notice that most of them are in up trends, regardless of which currency they arepriced. For example, a 3 year chart of Gold priced in any currency shows that it's in an uptrend.The race to the bottom has picked up in intensity. We would not be surprised now if some sort ofcrisis hits Asia; this would complete the circle perfectly. A position in precious metals isrecommended. View this as a hedge/insurance against another potential crisis; if you have noposition wait for strong pull backs before deploying new money.

The Greek economy was one of the fastest growing in the euro zone from 2000 to 2007; duringthat period, it grew at an annual rate of 4.2% as foreign capital flooded the country. A strongeconomy and falling bond yields allowed the government of Greece to run large structuraldeficits. 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 sincethe restoration of democracy in 1974. After the removal of the brutal right-wing military junta,the government wanted to bring disenfranchised left-leaning portions of the population into theeconomic mainstream. In order to do so, successive Greek governments have, among other
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things, customarily run large deficits to finance public sector jobs, pensions, and other socialbenefits. Since 1993 debt to GDP has remained above 100%.

Initially currency devaluation helped finance the borrowing. After the introduction of the euro inJan 2001, Greece was initially able to borrow due to the lower interest rates government bondscould command. The late-2000s financial crisis that began in 2007 had a particularly large effect

on Greece. Two of the country's largest industries are tourism and shipping, and both were badlyaffected by the downturn with revenues falling 15% in 2009.

To keep within the monetary union guidelines, the government of Greece (like many othergovernments in the Euro zone) had misreported the country's official economic statistics. In thebeginning of 2010, it was discovered that Greece had paid Goldman Sachs and other bankshundreds of millions of dollars in fees since 2001 for arranging transactions that hid the actuallevel of borrowing.

The purpose of these deals made by several subsequent Greek governments was to enable themto continue spending while hiding the actual deficit from the EU. The emphasis on the Greekcase has tended to overshadow similar serious irregularities, usage of derivatives and

"massaging" of statistics (to cope with monetary union guidelines) that have also been observedin cases of other EU countries; however Greece was the most publicized case.

In 2009, the government ofGeorge Papandreou revised its deficit from an estimated 6% (8% if aspecial tax for building irregularities were not to be applied) to 12.7%. In May 2010, the Greekgovernment deficit was estimated to be 13.6% which is one of the highest in the world relative toGDP. Greek government debt was estimated at 216 billionin January 2010. Accumulatedgovernment debt was forecast, according to some estimates, to hit 120% of GDP in 2010. TheGreek government bond market relies on foreign investors, with some estimates suggesting thatup to 70% of Greek government bonds are held externally.

Estimated tax evasion costs the Greek government over $20 billion per year. Despite the crisis,

Greek government bond auctions have all been over-subscribed in 2010 (as of 26 January).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) governmenthad 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.
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COURSE OF EVENTS

Monetary deflation

If one or more governments defaulted, northern European banks, which were large-scaleinvestors in government debt, would have massive loan and capital losses. The result of theselosses would be banks going out of business, calling in outstanding loans, or both, therebyreversing the money multiplier process and causing a decline in the money supply. The fallingmoney supplydeflationwould make the euro more, not less, valuable.

However, a more realistic threat to the euro is that some governments might shed it and return totheir own domestic currency. Fed up with the (prudent) restraint of money creation imposedupon them by the ECB, indebted governments might want to be able to print their way out oftheir trouble. But even if one or more countries walked away from the euro in favor of their owncurrencies, the euro could still be protected by the ECB.

This is because the ECB could exchange a particular country's old, previous currency for theeuro, thereby adjusting the euro money supply so that the volume of Euros in the remainingcountries remained the same. This operation would not alter the quantity of money in theeconomy; it would simply swap one type of money for another, keeping the overall purchasingpower constant.

Monetary inflation

The ECB has decided to take on the job, because European governments will not allowthemselves to face the political consequences of a banking collapse and the subsequent economicproblems that a debt deflation would bring about. Instead, they will, as all politicians do, delaythe day of reckoning and let taxpayers and future politicians suffer larger problems down theroad.

Printing money and increasing taxes and debt to the tune of more than a trillion dollars onthe (northern) European taxpayer in order to prevent bank losses is called by some "saving theeuro." But a question in case of would be why the euro worth paying such a price is?

With the higher prices and lower standards of living that "saving the euro" entails, all Europeansexcept bankers and politicians would be better off shedding the euro and returning to a"less expensive" currency. At the least, individual countries should decide if they want to forcetheir own citizens to suffer the consequences of printing money and over borrowing. Under thecurrent scenario, German and French citizens (mostly) will have to pay on behalf of theprofligate Portuguese, Irish, Italians, Greeks, and Spanish.


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REMEDIAL MEASURES TAKEN

Bailout PlanEuropean governments and the International Monetary Fund (IMF) have stunned global stock

markets with a 750bn-euro ($975bn; 650bn) package of standby funds designed to see offfinancial meltdown. The 27 countries of the European Union (EU) will contribute 500bn Eurostowards the financial safety net. They have been joined by the International Monetary Fund(IMF), which is providing other 250bn Euros. The vast bulk of Europe's contribution comes fromthe 16- nation Euro-zone bloc, which is promising 440bn in loan guarantees. The EuropeanCommission is providing 60bn Euros immediately.

Germany and the Euro rescue plan

Germany's parliament has approved the country's contribution to a 750bn euro ($938bn,651bn) rescue deal for the Euro-zone.

The German contribution is key to the plan, and would amount to up to 148bn Euros.Chancellor Angela Merkel warned that the Euro would be "in danger" without strong action.

The role of GreeceGreece has outlined plans to cut its budget deficit, or the amount its public spending exceedstaxation, to 8.7% of its GDP in 2010, and to less than 3% by 2012.

Just before the massive bail-out package was announced the Greek government pledged to

make further spending cuts and tax increases totaling 30bn Euros over three years - on top ofausterity measures already taken.


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ECB INTERVENTIONS

ECB Securities Markets Program (SMP) covering bond purchases from May 2010 till March2012

The European Central Bank (ECB) has taken a series of measures aimed at reducing volatility inthe financial markets and at improving liquidity.

In May 2010 it took the following actions:

It began open market operations buying government and private debt securities,reaching 219.5 billionby February of 2012, though it simultaneously absorbed the sameamount of liquidity to prevent a rise in inflation. According to Rabobank economist Elwin deGroot, there is a natural limit of300 billion the ECB can sterilize.

It reactivated the dollar swap lines with Federal Reserve support. It changed its policy regarding the necessary credit rating for loan deposits, accepting as

collateral all outstanding and new debt instruments issued or guaranteed by the Greekgovernment, regardless of the nation's credit rating.

The move took some pressure off Greek government bonds, which had just been downgraded tojunk status, making it difficult for the government to raise money on capital markets.

On 30 November 2011, the European Central Bank, the U.S. Federal Reserve Federal Reserve,the central banks of Canada, Japan, Britain and the Swiss National Bank provided globalfinancial markets with additional liquidity to ward off the debt crisis and to support the realeconomy. The central banks agreed to lower the cost of dollar currency swaps by 50 basis pointsto come into effect on 5 December 2011. They also agreed to provide each other with abundantliquidity to make sure that commercial banks stay liquid in other currencies.

Long Term Refinancing Operation (LTRO)
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The ECB conducts repo auctions as weekly main refinancing operations (MRO with a(bi)weekly maturity and monthly Long Term Refinancing Operations (LTROs) maturing afterthree months. In 2003, refinancing via LTROs amounted to 45 bln Euro which is about 20% ofoverall liquidity provided by the ECB.

The ECB's first supplementary longer-term refinancing operation (LTRO) with a six-month

maturity was announced March 2008. Previously the longest tender offered was three months. Itannounced two 3-month and one 6-month full allotment of Long Term Refinancing Operations(LTROs). The first tender was settled April 3, and was more than four times oversubscribed. The25 billion auctiondrew bids amounting to 103.1 billion, from 177 banks. Another six-monthtender was allotted on July 9, again to the amount of 25 billion.

The first 1y LTRO in June 2009 had close to 1100 bidders. On 22 December 2011, theECB started the biggest infusion of credit into the European banking system in the euro's 13 yearhistory. Under its LTRO it loaned489 billion to 523 banks for an exceptionally long period ofthree years at a rate of just one percent. The by far biggest amount of325 billion was tapped bybanks in Greece, Ireland, Italy and Spain. This way the ECB tried to make sure that banks have

enough cash to pay off200 billion of their own maturing debts in the first three months of 2012,and at the same time keep operating and loaning to businesses so that a credit crunch does notchoke off economic growth. It also hoped that banks would use some of the money to buygovernment bonds, effectively easing the debt crisis. On 29 February 2012, the ECB held asecond auction, LTRO2, providing 800 Eurozone banks with further 529.5 billionin cheaploans. Net new borrowing under the 529.5 billion February auction was around 313 billion;out of a total of 256 billion existing ECB lending (MRO + 3m&6m LTROs), 215 billion was

rolled into LTRO2.

Resignations

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, wasonce thought to be a likely successor to Jean-Claude Trichet as bank president. He and Starkwere both thought to have resigned due to "unhappiness with theECBs bond purchases, whichcritics 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 JensWeidmann, while Belgium's Peter Praet took Stark's original position, heading the ECB'seconomics department.

Economic reforms and recovery
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Increase competitiveness

Slow GDP growth rates correspond to slower growth in tax revenues and higher safety netspending, increasing deficits and debt levels. Fareed Zakaria described the factors slowinggrowth in the eurozone, writing in November 2011: "Europe's core problem [is] a lack ofgrowth... Italy's economy has not grown for an entire decade. No debt restructuring will work ifit stays stagnant for another decade... The fact is that Western economies - with high wages,generous middle-class subsidies and complex regulations and taxes - have become sclerotic.Now they face pressures from three fronts: demography (an aging population), technology(which has allowed companies to do much more with fewer people) and globalization (which hasallowed manufacturing and services to locate across the world)." He advocated lower wages andsteps to bring in more foreign capital investment. British economic historian RobertSkidelsky disagreed saying it was excessive lending by banks, not deficit spending that createdthis crisis. Government's mounting debts are a response to the economic downturn as spendingrises and tax revenues fall, not its cause.

To improve the situation, crisis countries must significantly increase their international

competitiveness. Typically this is done by depreciating the currency, as in the case of Iceland,which suffered the largest financial crisis in 2008-2011 in economic history but has since vastlyimproved its position. Since eurozone countries cannot devalue their currency, policy makers tryto restore competitiveness through internal devaluation, a painful economic adjustment process,where a country aims to reduce its unit labour costs. German economist Hans-Werner Sinn notedin 2012 that Ireland was the only country that had implemented relative wage moderation in thelast five year, which helped decrease its relative price/wage levels by 16%. Greece would need tobring this figure down by 31%, effectively reaching the level of Turkey.

Other economists argue that no matter how much Greece and Portugal drive down their wages,they could never compete with low-cost developing countries such as China or India. Instead

weak European countries must shift their economies to higher quality products and services,though this is a long-term process and may not bring immediate relief.

Progress

On 15 November 2011, the Lisbon Council published the Euro Plus Monitor 2011. According tothe report most critical eurozone member countries are in the process of rapid reforms. Theauthors note that "Many of those countries most in need to adjust are now making the greatestprogress towards restoring their fiscal balance and external competitiveness". Greece, Ireland
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and Spain are among the top five reformers and Portugal is ranked seventh among 17 countriesincluded in the report (see graph).

Increase investment

There has been substantial criticism over the austerity measures implemented by most European

nations to counter this debt crisis. Some argue that an abrupt return to "non-Keynesian" financialpolicies is not a viable solutionand predict that deflationary policies now being imposed oncountries such as Greece and Spain might prolong and deepen their recessions. In a 2003 studythat analyzed 133 IMF austerity programmes, the IMF's independent evaluation office found thatpolicy makers consistently underestimated the disastrous effects of rigid spending cuts oneconomic growth. In early 2012 an IMF official, who negotiated Greek austerity measures,admitted that spending cuts were harming Greece. Nouriel Roubini adds that the new creditavailable to the heavily indebted countries did not equate to an immediate revival of economicfortunes: "While money is available now on the table, all this money is conditional on all thesecountries doing fiscal adjustment and structural reform."

According to Keynesian economists "growth-friendly austerity" relies on the false argument thatpublic cuts would be compensated for by more spending from consumers and businesses, atheoretical claim that has not materialized. The case of Greece shows that excessive levels ofprivate indebtedness and a collapse of public confidence (over 90% of Greeks fearunemployment, poverty and the closure of businesses) led the private sector to decrease spendingin an attempt to save up for rainy days ahead. This led to even lower demand for both productsand labor, which further deepened the recession and made it ever more difficult to generate taxrevenues and fight public indebtedness.

Instead of austerity, Keynes suggested increasing investment and cutting income tax for lowearners to kick-start the economy and boost growth and employment. Since struggling Europeancountries lack the funds to engage in deficit spending, German economist and member of

the German Council of Economic Experts Peter Bofinger and Sony Kapoor from global thinktank "re-define" suggest financing additional public investments by growth-friendly taxes on"property, land, wealth, carbon emissions and the under-taxed financial sector". They also calledon EU countries to renegotiate the EU savings tax directive and to sign an agreement to helpeach other crack down on tax evasion and avoidance. Currently authorities capture less than 1%in annual tax revenue on untaxed wealth transferred to other EU members. Furthermore theysuggest providing40 billion in additional funds to the European Investment Bank, which couldthen lend ten times that amount to the employment-intensive smaller business sector.

Apart from arguments over whether or not austerity, rather than increased or frozen spending, isa macroeconomic solution, union leaders have also argued that the working population is being

unjustly held responsible for the economic mismanagement errors of economists, investors, andbankers. Over 23 million EU workers have become unemployed as a consequence of the globaleconomic crisis of 20072010, and this has led many to call for additional regulation of thebanking sector across not only Europe, but the entire world.
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IMPACT ON OTHER COUNTRIES ACROSS THE WORLD

Strong economic growth and domestically-funded fiscal deficit are likely keep the country's debt

position stable even if the financial crisis in Europe worsens"Although India, with a fiscal deficit forecast at 8.5 per cent in 2010, may seem vulnerable toany worsening of the European fiscal crisis, its strong growth trajectory should ensure that itsdebt dynamics remain stable, while its deficit is primarily domestically-funded,".

Eurozone nations like Greece, Spain and Portugal are facing financial crisis because of heavyborrowings by their governments, leading to erosion in investor confidence across the world.

There has been widespread belief that the European crisis could affect other parts of the world,especially those countries which have high deficits, mainly on account of internationalborrowings.

Citi's first Global Emerging Markets Strategy Report, covering 22 nations, puts India in "neutral"category along with China, Chile, Mexico and South Africa. Listing its top picks, the report says,"our "overweight" calls are Taiwan, South Korea, Russia, Brazil, Turkey, Thailand; we are"neutral" in China, India, Chile, Mexico and South Africa."

It projects India's economic growth at 8.5 per cent during 2010 and estimates the overall size ofthe Indian economy (GDP) at USD 1.67 trillion.

It estimates that the country's inflation would be 8.4 per cent during the year, and lead totightening of policy rates by the Reserve Bank. "India scores well on earnings and GDP growth...However, rising inflationary pressures may force a more rapid tightening of policy," the Citi

report said.

As for China, it cautioned about a property bubble and said the government's efforts to bring theprices down would cut Chinese GDP growth by 3 percentage points in a full year.

For Asia as a whole, the report says the region is its favorite and assigns it in the "overweight"category. However, it cautions: "Asia is at risk from slower export growth to Europe, if the crisisintensifies, and the effects on growth of a property collapse in China."

For the overall forecast for the emerging markets, which constitute 29.6 per cent of the globalGDP at USD17.8 trillion, the report said, "our forecast is for around 15 per cent returns inemerging equity markets in 2010, with a continuing pattern of volatility within a rising trend."

It said its long-term positive/bullish outlook on the emerging markets is based on the fact that theglobal economy is in the early stages of a new upswing and an anticipation of strong corporateearnings growth.

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The Irish sovereign debt crisis was not based on government over-spending, but from the stateguaranteeing the six main Irish-based banks who had financed a property bubble. On 29September 2008 the Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to thebanks' depositors and bond-holders. He renewed it for another year in September 2009 soon afterthe launch of the National, a body designed to remove bad loans from the six banks.

The December 2008 hidden loans controversy within Anglo Irish Bank had led to theresignations of three executives, including chief executive Sean Fitz Patrick. A mysterious"Golden Circle" of ten businessmen are being investigated over shares they purchased in AngloIrish Bank, using loans from the bank, in 2008. The Anglo Irish Bank Corporation Bill 2009 waspassed to nationalise Anglo Irish Bank was voted through Dil ireann and passedthrough Seanad ireann without a vote on 20 January 2009. President Mary McAleese thensigned the bill at ras an Uachtarin the following day, confirming the bank's nationalisation.

In April 2010, following a marked increase in Irish 2-year bond yields, Ireland's NTMA statedebt agency said that it had "no major refinancing obligations" in 2010. Its requirement for 20billion in 2010 was matched by a 23 billioncash balance, and it remarked: "We're verycomfortably circumstanced. On 18 May the NTMA tested the market and sold a 1.5 billionissue that was three times oversubscribed.

By September 2010 the banks could not raise finance and the bank guarantee was renewed for athird year. This had a negative impact on Irish government bonds, government help for the banksrose 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. In February thegovernment lost the ensuing Irish general election, 2011. In April 2011, despite all the measurestaken, Moody's downgraded the banks' debt to junk status. Debate continues on whether Irelandwill need a "second bailout".

Portugal

A report published in January 2011 by the Dirio de Notciasdemonstrated that in the periodbetween the Carnation Revolution in 1974 and 2010, the democratic Portuguese Republicgovernments have encouraged over-expenditure and investment bubbles through unclear public-private partnerships and funding of numerous ineffective and unnecessary external consultancyand 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 publicservants. Risky credit, public debt creation, and European structural and cohesion funds weremismanaged 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 thesituation when the country was on the verge of bankruptcy by 2011.

Robert Fishman, in the New York Times article "Portugal's Unnecessary Bailout", points out thatPortugal fell victim to successive waves of speculation by pressure from bond traders, ratingagencies and speculators. In the first quarter of 2010, before markets pressure, Portugal had oneof the best rates of economic recovery in the EU. Industrial orders, exports, entrepreneurial
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innovation and high-school achievement the country matched or even surpassed its neighbors inWestern Europe.

On 16 May 2011 the Eurozone leaders officially approved a 78 billion bailout package forPortugal. The bailout loan will be equally split between the European Financial StabilisationMechanism, the European Financial Stability Facility, and the International Monetary

Fund.According to the Portuguese finance minister, the average interest rate on the bailout loanis expected to be 5.1% As part of the bailout, Portugal agreed to eliminate its goldenshare in Portugal Telecom to pave the way for privatization. Portugal became the third Eurozonecountry, 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 ratingto junk status, Moody's also launched speculation that Portugal may follow Greece in requestinga second bailout.

SpainShortly after the announcement of the EU's new "emergency fund" for eurozone countries inearly May 2010, Spain's government announced new austerity measures designed to furtherreduce the country's budget deficit. The socialist government had hoped to avoid such deep cuts,but weak economic growth as well as domestic and international pressure forced the governmentto expand on cuts already announced in January. As one of the largest eurozone economies thecondition of Spain's economy is of particular concern to international observers, and facedpressure from the United States, the IMF, other European countries and the EuropeanCommission to cut its deficit more aggressively.

According to the Financial Times, Spain has succeeded in trimming its deficit from 11.2% ofGDP in 2009 to 9.2% in 2010. It should be noted that Spain's public debt (60.1% of GDP in2010) 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%).

Belgium

In 2010, Belgium's public debt was 100% of its GDP the third highest in the Euro zone afterGreece and Italy and there were doubts about the financial stability of the banks. Afterinconclusive elections in June 2010, by July 2011 the country still had only a caretakergovernment 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. Financial analystsforecast that Belgium would be the next country to be hit by the financial crisis as Belgium'sborrowing costs rose.

However the government deficit of 5% was relatively modest and Belgian government 10-yearbond yields in November 2010 of 3.7% were still below those of Ireland (9.2%), Portugal (7%)and Spain (5.2%). Furthermore, thanks to Belgium's high personal savings rate, the BelgianGovernment financed the deficit from mainly domestic savings, making it less prone tofluctuations of international credit markets.
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United States:-

A THREAT TO THE U.S. ECONOMY

The United States has a vital interest in assuring that the crisis across the Atlantic is contained.The country is tightly linked to Europe via trade, investment, and financial markets, and the Euro

crisis is already affecting the U.S. economy. If the crisis were to spread further across Europe,the sound conduct of U.S. monetary and fiscal policy could also come under threat. The UnitedStates has taken action to help ease the crisis, restarting the Federal Reserves dollar-swap line inearly May and supporting the IMFs participation in the European rescue plan. The United States

should also accept a weaker euro for some time. In exchange, it can exercise moral suasion toencourage fiscal consolidation and structural adjustment in the vulnerable Euro area countriesand more expansive policies in the surplus ones.

Effects on the United States

The trade and investment links between the United States and the European Union (EU) aresignificant. Europe consumes twenty percent of U.S. exports and holds more than 50 percent ofU.S. overseas assets, while the United States holds close to 40 percent of Europes foreign assets.Lower growth and higher volatility in Europe could therefore have serious consequences for theUnited States, hindering export growth and endangering assets. Europe has already shown itselfto be the laggard in the global and the situation may well get worse before it gets better.

The crisis will likely lead the euro to depreciate further in the coming months. The euro hasalready fallen more than 20 percent against the dollar since late Novembertwo months beforeObama unveiled his goal of doubling exports in the next five yearsand it may fall to parity. In

sectors where U.S. and European exports overlap (e.g., aircraft, machinery, professionalservices), a lower euro will hinder the competitiveness of U.S. goods on the global market. Thedepreciation will also reduce the purchasing power of European tourists traveling to the UnitedStates and make European goods relatively cheaper in U.S. markets at a time when policymakers are hoping to avoid a return to high current account deficits. With imports likely to riseand exports likely to fall, the U.S. bilateral trade balance with Europe will likely deteriorate. Bydefinition, the profitability of U.S. companies operating in Europe will be affected by the Eurocrisis when profits and assets on the balance sheets are expressed in dollars. U.S. companiesselling in Europe and sourcing in dollars will see even sharper profit declines, though U.S.companies selling into the dollar area and sourcing in Europe will benefit.

Despite the negative effects a weaker euro would have on U.S. job creation, the most importantconsequences of the Euro crisis in the United States will operate through financial and, morespecifically, banking channels. Though the exposure of U.S. banks to the most vulnerablecountries in Europe is limited to $176 billion, or 5 percent of their total foreign exposure, theirindirect linkages to these countries, which operate through all of the international banks, aremuch larger. Not surprisingly, European banks hold large amounts of their own countries bonds


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and, according to a recent World Bank report, these holdings exceed reserves in some instances.A string of bank failures in Europe could well trigger another global credit crunch.

The crisis has already significantly increased stock market volatility; the VIX volatility indexmore than doubled in the last two months. The confidence that banks have in doing business with

each other has also plummeted, with the TED spread, the difference between the three-monthinter-bank lending rate and the yield on Treasury bills, reaching a nine-month high of 35 basispoints in May, up from 10.6 basis points in March.

Stopping the Spread

These worries come against a background where the crisis has been largely confined to Greece, acountry that accounts for 2.6 percent of the Euro areas total GDP. One can only imagine what

would happen if the crisis spread to Spain or Italycountries 5 to 6 times larger. The trade,investment, and financial problems would clearly balloon, but a spreading Euro crisis would also

hurt U.S. interests in three other fundamental ways:1. Although a spreading Euro crisis could initially lead U.S. government debt to fall in price dueto a safe haven effect, it will place the spotlight on the high and rapidly rising debt levels of theUnited States. This could force a large rise in the yield that investors demand to hold U.S. debt,aggravating the countrys unstable debt dynamics. At the same time, the United States does

enjoy obvious advantages compared to individual European countries, given that the dollar floatsfreely.

2. If the crisis were to spread, it would prolong the timeframe during which the European CentralBank maintains low policy rates, making the United States less likely to raise its own rates. This

could aggravate the liquidity overhang with difficult-to-predict consequences as well asaccentuate imbalances in the economy.

3. Were a spreading Euro crisis to trigger defaults and lead a number of European countries toleave the Euro area, it could undermine the viability of the wider European project, including theaccession of several countries in the East. This could create a new frontier of geopoliticalinstability all around the European periphery and further the decline in confidence.

Thus, for the United States, the dangers involved in a spreading Euro crisis clearly outweigh thecosts of supporting the European adjustment by accepting a lower euro, expanding the resources

available to the IMF, and expanding the Feds currency swap operations. In return, the UnitedStates can add its weight to the push for necessary adjustments within Europe.

India and other Developing Countries:-

The Euro crisis threatens the economic stability of much more than the Euro area alone. Aweakened Europe implies slower export growth in developing countries as well as increased


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financial volatility. The Euro crisis may also be only the first episode in which post-financial-crisis vulnerabilities converge to such devastating effect, implying that similar dangers fordeveloping countries could emerge from sovereign debt crises in other regions or another globalcredit crunch. Policy makers in emerging markets can take a variety of steps, outlined below, tolimit the potential consequences right now. In addition, the crisis underscores the importance of

the IMF as a lender of the last resort.

Impact of the Crisis on Developing Countries

Exports: The Euro crisis is likely to deduct at least 1 percent of growth, and potentiallymuch more, from Europea market that consumes more than 27 percent of developingcountries exports, In addition, the euro has already devalued more than 20 percent

against the dollar since November 2009 and the two could reach parity before the crisis isover. A lower euro will sharply reduce the profitability of exporting to the Europeanmarket and will also increase competition from Europe in sectors ranging from

agriculture to garments and low-end automobiles. Tourism and Remittances: A lower euro will reduce the purchasing power of European

tourists traveling to developing countries, and the value of remittances originating fromEurope.

Domestic Competition: At the same time, a lower euro may provide opportunities forconsumers and firms to import from Europe at a lower cost.

Capital Flows: The Euro crisis will force the European Central Bank to maintain a verylow policy interest rate for the foreseeable future. Similarly low rates in Japan and theUnited States, combined with low growth in Europe, may lead even more capital to flowto the fastest-growing emerging markets. This will lead to inflation and currencyappreciation pressures, as well as increase the risk of asset bubbles and, eventually, ofsudden capital stops in emerging markets.

Market Volatility: The Euro crisis will add greatly to the volatility of financial marketsand will lead to sharp bouts of risk-aversion. The VIX index, which measures the cost ofhedging against the volatility of stocks, has more than doubled in the last two months.This, in turn, has increased the level and volatility of spreads on emerging marketbondswhich have risen by more than 130 basis points since Apriland will makecurrencies more volatile across the globe.

Credit Availability: The Euro crisis may constrain trade and other bank credit available todeveloping countries as it raises questions about the viability of European banksespecially those based in vulnerable countries whose assets likely include large amountsof their own governments bonds. But all international banks will be viewed as havingeither direct or indirect (through other banks) exposure to the vulnerable countries. Theconfidence that banks have in lending to each other has already fallen; the TED spread(the difference between the three-month inter-bank lending rate and the yield on three-


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month Treasury bills) reached a nine-month high of 35 basis points in May, up from thisyears low of 10.6 basis points in March.

Policy Implications

Though there are no one-size-fits-all prescriptions for developing countries given their verydifferent starting points, some general policy conclusions emerge:

Developing countries will need to rely less on exports to the industrial countries and more on

their own domestic demand and South-South trade.

In some cases, greater caution may be called for in reversing stimulus policies. In other cases,even greater prudence may be called for in containing fiscal deficits and moderating theaccumulation of public debt.

Given the sharp rise in exchange rate uncertainty, matching the currencies of foreign liabilities

with those of export proceeds and reserve holdings will become even more important.

The Euro crisis also calls for great caution in the way surging capital inflow is managed. In

some countries, regulations to moderate the inflow of portfolio capital and to instead encouragethe more stable form of foreign direct investment may be warranted.

Countries with large external surpluses and that receive large capital inflows may allow their

currencies to appreciate, as this may help both stimulate domestic demand and moderateinflationary pressures.

Close monitoring and tight regulation of the operation of foreign banks and of their links with

domestic banks may be prudent in the current circumstances.

Two other important policy lessons flow from the Euro crisis experience to date: one is areinforcement of the message that strictly pegged exchange rates together with open capitalaccounts and the ability to borrow abroad in foreign currencies are often a dangerouscombination. Just as a tight peg to the U.S. dollar led to significant GDP contraction in Argentina(18.4 percent from 1998 to 2002), countries that are not part of the Euro area but had peggedtheir currencies to the euro many years ago have seen their GDP decline sharply. GDP in Latvia,Estonia, and Lithuania, for instance, will have contracted by 24.8 percent, 16.5 percent, and 14.1percent, respectively, from 2007 levels by the end of 2010. Countries with flexible exchange

rates, such as Poland or Brazil, and those with pegged exchange rates but tight capital controlsappear to have dealt with the dislocation caused by the crisis more successfully.

Last but not least, the crisis has exposed the limitations of regional mechanisms in dealing withfinancial crisiseven among countries with deep pocketsand underscored instead the vitalrole that a global lender of last resort, in the form of the IMF, can play. Not only can theinstitution bring more resources and broader expertise than would plausibly be available to a


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regional institution, but its distance from potentially divisive regional politics can also be a bigasset.


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IMPACT ON TRADE

The financial and economic crisis has revealed the fundamental problems of the free tradeparadigm: free trade can lead to huge trade surpluses and deficits among countries with unequaltrade capacity and unequal trade, economic and social policies. These trade imbalances andresulting current account deficits were first blamed to have contributed to the crisis and are nowconsidered to be an obstacle to recovery of those countries with a trade deficit, such as the US,and create foreign exchange problems for some countries face (see below).

It needs to be said openly: if China had not been member of the WTO, it would not have beenable to build up a such a trade surplus without new barriers by others. Of course, the US neverthought that its bullying stance in favour of free trade at the WTO and in FTAs would bring it ina position of a huge trade deficit without means to intervene. The US had been pushing very hardduring and after the Uruguay Round to liberalise financial services and restrict governmentsfrom (re)regulating them. Consequently, financial complex and speculative products andfinancial operators spread around the world in an unregulated way, contributing to the financialcrisis.

The recent proposal by US at the G20 to limit current account deficits and surpluses below 4% ofa countrys GDP, is in fact admitting that the free trade does not work. But now, the US proposal

is inacceptable to others. In anyway, it would intervene with the WTO rules and FTAs which arebinding international laws.

The impact of the crisis on trade

The crisis has shown the dangers of the free trade paradigm: in times of crisis, all countries wantto export their way out of the crisis through export strategies, which is a situation that existed inthe pre-war period in the 1930s. However, export strategies that lead to trade surpluses in onecountry result in trade deficits elsewhere. The Bretton Woods system after World War II haddesigned a mechanism to intervene against countries with trade and current account surpluses ordeficits, through the IMF. However, this and other attempts failed to tackle trade imbalances andthe US did not want to submit itself to external control.

Now, the WTOs negotiation round, the so-called Doha Development agenda, is stalled becausethe advanced countries want more access for their exports to overcome the crisis, while many

developing countries still have not seen many of their interests included in the current draft texts.In FTAs, advanced countries are pushing hard to defend their comparative advantage (such asaccess for services, more protection of intellectual property rights) and maintain access to rawmaterials (a major comparative weakness of the EU). At the same time, more constituencies inthe rich countries raise their voices to not allow more imports e.g. in US and EUs FTA withSouth Korea.


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The financial crisis and its aftermath revealed major weaknesses and vulnerabilities of countriesthat submitted themselves to free trade regimes and export-lead strategies. The benefits of freetrade do not only come from open markets, but also depend very much on:

the value of foreign exchange rates, which became very volatile during the crisis and underminedexports when the exchange rate of exporting countries went up;

credit for trade, which shrank dramatically during the crisis; credit for production, which was lacking in countries where foreign banks (whose presence was

supported by free trade agreements in financial services) were repatriating capital or veryrestrictive in providing credit due to the crisis;

foreign direct investment and portfolio investment as far as it was beneficial for (export)production, which declined sharply when the financial crisis broke out and portfolio investmentwithdrew;

purchasing power in the import markets, which dropped in Western markets due to the financialand economic crisis, leading to less export earnings and job losses in exporting countries; and the

the debt situation of a country, which increased for some countries after they had to borrow againdue to the crisis with acceptance of harsh and unsustainable loan conditionalities.

Currency wars instead of trade wars

The crisis has also clearly proven that free trade combined with free movement of capitalreinforces balance of payment, trade and economic imbalances, which was already recognised byKeynes. Since capital always flows where it gets most profits, it now flows to a few boomingcountries while other countries suffer from outflows and lack of productive credit. Currently,emerging countries are suffering from huge capital inflows because returns on investment in

advanced countries are so low.

So, even it the US is printing money (quantitative easing) to stimulate its own economy, dollars

are leaving the US and freely flowing into other countries with high economic growth and wholiberalised their capital account. Since emerging market countries exchange rate is increasing

due to these speculative capital inflows and not so much because of more trade, and becausetrade agreements keep trade liberalised, they are intervening in currency markets and imposingall kind of capital or currency controls to stop an increase in exchange rate (e.g. Brazil, SouthKorea).

However, the rules on capital movements in FTAs and in the services agreement in theWTO impose strict conditions on the use of capital controls, often forbidding their use forpreventive measures as is currently the case. Moreover, the huge capital flows are stimulated byunregulated speculators (hedge funds etc.) and financial operators (derivatives traders, carrytraders) whose presence worldwide has been stimulated and protected through free trade in(financial) services agreements.


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Some controls on capital inflows via restrictions on currency swaps trading or taxing short terminvestment, are in breach of rules on free trade in financial services under the WTO and FTAs bythose countries that made commitments in financial services liberalisation. Trade treaty ruleshardly allow to stop speculative trading in food commodity derivatives can hardly be stopped bycountries which have liberalised derivative trading through free trade agreements. Some trade

agreements that cover financial services can even prevent financial reforms.

What does does this all mean for new FTAs being negotiated?

The current crisis and its consequences have shown that developing countries need to maintainpolicy space to protect themselves against gaps in international economic governance and themany pitfalls of the free trade paradigm.

At a minimum, the current restrictions on capital controls, as worded in different FTAs signed bythe EU, should be changed so that preventive measures against speculation and volatility can be

taken. Also, the EU might need to reconsider its constitution (Lisbon Treaty), which only allowsthe EU countries to restrict freedom of capital movement in very exceptional circumstances.In addition, there should be no rules that prohibit a needed ban or regulation of financial services.There should be a treaty obligation for tightly regulate and supervise financial services andprevent excessive speculation. There should be no further negotiation to liberalise financialservices unless international regulation and supervision are in place.

Given the many pitfalls and problems with the free trade paradigm, the principle of competing toget most access for exports should be replaced with cooperation to manage trade. The aim oftrade agreements should not be trade as such but equitable and sustainable production, trade and

consumption. This would need complete overhaul of the WTO and FTAs. Unfortunately, the EUis still under the illusion that free trade is the only existing paradigm and policy.


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LESSONS LEARNT

There are two fundamental groups of countries in the Eurozone, the first bloc comprises ofcountries in Northern Europe, such as Germany, Norway or Finland. The shared characteristics

of these countries are high productivity, modern technology and surplus of current account. Theother group is formed by countries in Southern Europe, such as Greece, Spain and Portugal.They all have lower productivity than the north and have deficit of current account. We can seehow serious imbalances in the Eurozone developed by taking Germany and Greece asrepresentatives of two groups.

Economically strongest member of the north, Germany, has been lacking domestic demand,because of high propensity to save of its households. Therefore it has followed export-led growthwith many of the exports going to Greece and other countries in south of Europe. However,Greece was not able to produce any goods or services that German consumers would beinterested in. German banks solved the problem by taking savings generated by thrifty Germanhouseholds and lending them to households and government in Greece. Current account deficitsof Greece were compensated by its capital account surpluses, that means by lending fromGerman banks. This is how serious imbalances developed. Both sides hugely benefited fromthese transactions. Germany benefited from high economic growth and low unemployment, itshouseholds could continue to save and accumulate financial wealth. Greeks also benefited, asthey could enjoy much higher living standards than they would otherwise have. They couldbasically consumer goods produced by Germans in exchange for promises to pay for them in thefuture.

The existence of single currency further exacerbated the imbalances by enabling Greek and otherSouth European governments to borrow at the same interest rate as German government, asbonds of all Eurozone countries were perceived to have the same low risk of default as German

bonds. Interest rates set by the ECB for the entire Eurozone were very low and this cheap creditenabled massive property and lending booms in the European periphery. This way Greeks andother nations in the periphery ran up massive debts, in case of Greece it was mostly governmentdebt, in case of Spain and Ireland it was private debt. On the other hand, Germans accumulatedhuge piles of financial assets which made them feel wealthy. Martin Wolfwrote an excellent andwitty comment on this topic in the Financial Times where he uses the traditional fable of antsand grasshoppers to explain situation in the Eurozone. He compares hardworking Germans toants and careless Greeks and other South Europeans to grasshoppers. However, moral of hisstory is different than the one of the original fable.However, at a certain point investors decided that debt in Greece was unsustainable, or as Wolfwrites trees do not grow to the sky. German government suddenly realised that if Greece

defaults on its debt, German banks would lose a great deal of money. Significant part of savingsof German households would suddenly be at risk. Therefore German government would have tobail out its banks to protect domestic savers. However, German government was worried thatthrifty German savers would be absolutely frightened and angry if they realised that their hard-earned savings were effectively spent by wasteful and lazy Greeks. There was also a risk ofpanic and of collapse of the fragile European banking sector. Therefore German governmentdecided to adopt different policy and make yet more loans to the Greek government. However,the loans came with a set of tough conditions; Greeks have to basically prove that they can
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behave like Germans. That means fiscal discipline, deep cuts in government spending, tax rises,structural reforms, wage deflation, all extremely painful and unpopular.

The loan to Greece was followed by a bailout of Ireland and bailouts of Spain and Portugal arestill possible. This is where we are now. My main point is that Germans and Greeks, or north ofEurope and south of Europe, are both responsible for the current crisis. They both benefited from

the boom and they should both share the consequences of their foolish behaviour. Germansshould have known that lending to careless Greeks was never going to be a way of accumulatingenduring wealth. Greeks willingly accepted those loans and lived beyond their means for manyyears, so it is right that they know face period of difficult transition.

However, there is a third group of countries in the Eurozone that had nothing to do with thisboom, that did not benefit from it, but is now asked to pay the bill as everyone else. Sloveniajoined the Euro in 2007, Slovakia in 2009 and Estonia in 2011. These countries have been askedto take part in a proposed solution to the crisis which are the loan to Greece and EurozoneStability Mechanism, where all Eurozone countries have to contribute towards emergency loansto troubled countries. The unfairness of this situation is especially stark in the case of Slovakia

which joined the Eurozone just after the party stopped and was asked to pay the bill for a feastthat it did not take part in. The crucial thing is that Slovakia does not fit to any of the twodominant groups in Eurozone, as it is neither a current account deficit or a surplus country.Its current account deficit is very small, it is only 1.3% of GDP. By comparison, Germanyscurrent account surplus is 6% of GDP, Netherlands surplus is 5.7% of GDP, Greece suffers fromenormous 10.8% current account deficit and Portugal is not doing any better with deficit of9.98% of GDP. Leaving the Euro and returning to Slovakias former currency, koruna, would bea radical policy associated with enormous transition costs, but might actually be the least bad ofall options.

What are the solutions to this crisis? Bailouts of Greece and Ireland are not solving thefundamental issue of solvency, they are only providing liquidity. The only thing that can savethese economies in the long run is economic growth, without grout they will not be able toservice their debt, or prove their ability to repay it in the future. The only alternative other thandefault is that these economies grow out of their debts. As governments and households introubled countries are in difficult process of de-leveraging, slowly paying off their debt, theireconomies suffer from lack of aggregate demand. Therefore the only possible source of risingdemand in the following years can be external demand from countries like Germany. In the nextcouple of years Greece and other countries in similar situation will have to pursue strategy ofexport-led growth.

However, right now Greek and other south European producers are very uncompetitivecompared to German producers. During the last decade German economy experienced wage

growth much slower than growth in productivity which meant that German internationalcompetitiveness has been rapidly rising. At the same time there was rapid growth in wages incountries like Greece without significant increases in productivity. The consequence waswidening gap in competitiveness.

Greeks and others now need to quickly regain competitiveness by wage deflation, cuts in wagesshould result in lower production costs and higher competitiveness of Greek producers inrelation to German producers. Because of Euro both Germans and Greeks are in a fixed


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exchange rate regime where differences in competitiveness cannot be solved by movements inthe exchange rate. If Germans had Deutschmark and Greeks their Drachmas then Greek currencywould simply depreciate as a result of worries about Greek government finances which wouldmake Greek exports cheaper. However, in this situation is not possible and therefore Greece,Ireland, Spain and Portugal have to go through painful process of internal devaluation through

reductions in nominal wages.Instead of admitting their share of responsibility, German government argues that the wholecrisis was caused by irresponsibility of governments in southern Europe and that fiscalindiscipline was the only cause of the sovereign debt crisis. They prescribe policy of austerityand fiscal tightening to the countries in periphery. By doing this they put the entire burden ofadjustment on countries like Greece. Basically they want people in Southern Europe to behavelike Germans. This approach can never work. If all European countries behaved like Germanythen Europe would become a big Germany with huge current account surplus. Who would buyall those exports? Europe would have to start exporting to Mars, there would simply not beenough demand in the world for all the European exports. German model of current accountsurplus is unbalanced and unsustainable in the same way as Greek model of current account

deficit. It is the other side of the same coin.

The only viable model for the Eurozone in the long run is that Germans would become a bit likeGreeks and Greeks would become a bit more like Germans. To put it simply, Germans need tospend more and Greeks need to save more. Countries in the periphery cannot carry the entireburden of transition, countries in the economic core of Eurozone, such as Germany have to helpthem. German government should allow wages to grow faster, at perhaps 5% per year andtolerate much higher than 2% inflation. On the other hand, Greek government has to pushthrough painful wage deflation and cuts in nominal wages across the board at perhaps 10% peryear. This way both parties would share the burden of transition.


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CONCLUSION

In conclusion , Europe will be given the financial means in the short medium term, allowing himto emerge from the crisis of sovereign debt and longer-term research a new compromise policy

(economic governance and fiscal policy in common) that which implies that the market works instep with democracy, or it will implode with all the consequences we can imagine. The future ofthe United States of Europe has never been more uncertain.

The ongoing European sovereign debt crisis continues to shake financial markets and the Eurozone. The International Monetary Fund and the European Union (EU) have acted swiftly todiminish panic and uncertainty by providing emergency assistance to Greece, Ireland andPortugal. However, uncertainty remains and queries have arisen over the vigor and effectivenessof multi-lateral institutions like the EU.

In the wake of the crisis, financial analyst asserted that a lingering flaw of the EuropeanCommission is its inability to address problems until they become crises. This crisis has warnedgovernments throughout the globe of the dangers of fiscal wanton. Britain along with otherEuropean nations introduced a salvo of austerity measures to prevent a debt crisis.

The US is currently contemplating numerous options to cut the deficit, which if implemented,could have profound consequences for our social and political future. Johnson goes on to claimthat only when crisis erupts can the EU can come together to develop solutions. If so, thequestion now is how the EU can succeed in the long-term if it does not have the capacity to

address problems early?

Perhaps, the most important lesson of this episode was the realization that public policychallenges can no longer be postponed as they used to be. The wages of evasion are clearly toocaustic for any country or region to pay. A new public policy ethos is essential if progress is tobe made. However, if this lesson is ignored, the EU or other nations may face a future crisis orproblem. It is hard to then imagine the ramifications on the region and the rest of the world.

The crisis in Europe shows that there are always potential

risks for any region that implementsa single currency

among countries that have huge economic, monetary social, historical,cultural

and religious differences.


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