Every day seems to bring another forecast of impending economic doom in Europe. Wild stock market swings, rioting in the streets, "dollar liquidity swap arrangements," leveraging the European Financial Stability Mechanism" — what are these people, with their foreign tongues and funny names, talking about? We’ve put together an FAQ (in English, natch) for those who are not just confused, but hopelessly mired in ignorance.
So Europe, that’s some kind of soccer league, right?
Europe is a continent.
Not ringing any bells.
It’s the continent that hosted the most recent season of Jersey Shore.
Oh, Europe. Gotcha.
But the current crisis mostly affects the seventeen-nation eurozone, a group of countries in Europe that use the same currency, the euro, which is like their version of the dollar.
Which nations are we talking about? Not the Jersey Shore one, I hope.
Yes, Italy, along with other large nations in Western and Central Europe, like Germany and France, and smaller countries like Greece and Finland.
You forgot England, dummy!
No, the U.K. still uses the British pound.
That can’t be right.
Look it up. Britain may not be in the eurozone, but its economy is just as susceptible to a collapse of the euro as countries that do use the currency.
Collapse? Are we talking 2012, John-Cusack-flying-planes-over-crumbling-ruins-style chaos here?
If that imagery helps you, fine. The most pessimistic prognosticators think that a breakup of the eurozone would be economically calamitous for Europe and result in a global recession for everyone else.
I still don’t know what the problem is.
The problem is the common currency between countries. For a lot of reasons, the euro has been useful: Countries using it can borrow in a larger, more unified bond market at lower interest rates; inflation can be kept in check by one central bank instead of many; and citizens and businesses don’t need to exchange their currencies every time they cross a border, or trade between nations.
My family hosted a foreign exchange student once. She was hot.
That’s not —
So the euro sounds great.
For a while, it was. But even though these nations all shared a currency, they were still otherwise running their economies independently, and over time, imbalances built up. Germany was running an efficient, export-driven economy and squirreling away cash, while Greece was borrowing to the hilt but without making its economy any more dynamic or competitive. Yet, both could borrow at similarly low interest rates.
Because they used the same currency, right?
Exactly. But Greece’s debt had to be paid back eventually. After the global financial crisis hit, Greece’s lenders stepped back and realized that its debt — at the time about 15 percent larger than its total annual income — made it significantly more likely to default in a bad economy, especially compared to a strong country like Germany. It was also later uncovered that Wall Street had helped Greece conceal the full extent of its debt load.
Devious! So Greece is in the doghouse now?
Yeah, but the trouble goes way beyond Greece. There are also the rest of the PIIGS.
Swine flu! Shit, I knew that wasn’t over.
No – PIIGS: Portugal, Italy, Ireland, Greece, and Spain. All are countries that have lots of debt relative to the size and strength of their economies. Investors worry that any one of them could default, and bailing out one will just make lenders freak out about the next miscreant in line. You see it in interest rates: Italy’s short-term borrowing rates almost doubled from about 3.5 percent in October to 6.5 percent in November. European businesses are getting squeezed now, too, which bodes ill for these economies. At some point, it simply becomes too expensive to keep rolling over debt, even with painfully deep cuts to government spending.
So they can all declare bankruptcy. It’s easy, my cousin’s done it like four times.
They could default, yeah, but that might be catastrophic. Banks all over Europe hold Greek and other euro debt, and Greece or any other country defaulting could ripple out and cause bank failures and economic earthquakes the world over.
Why should I care about this? I don't even have a passport.
The tremors would almost assuredly be felt in the U.S., since American banks lend to European banks and vice versa. More of our banks could fail, or need big government bailouts, it would almost certainly lead to more people being unemployed. Economists have termed this viral spread of financial ruin the “contagion” effect.
Right, I think I heard about this in that documentary with Gwyneth Paltrow.
Please stay focused. The other eurozone countries have tried to find a work-around solution to the contagion and default issues. They created something called the European Financial Stability Facility (EFSF). In a nutshell, Europe bands together to substitute its collective, good credit for the troubled countries’ weak credit. In return, investors take modest losses on their existing holdings of debt and receive new “good” debt, and countries like Portugal and Greece pledge to take a meat ax to their budgets so this doesn’t happen again.
It’s a Catch-22.
Not at all.
I’ve just always wanted to say that. Anyway, will the EFSF work?
The EFSF might be adequate to bail out smaller euro countries, but Italy and Spain are probably out of its league. And markets are already starting to move against Italy. Plus, Germany and other nations contributing to the EFSF must pass the bailouts through their legislatures, and it’s not popular with voters, who just see their tax dollars going to prop up foreign economies. In the end, it’s unclear if Europe can really pull together. It’s basically a choice between economic suicide and political suicide.
Now that’s totally a Catch-22.
Can’t the “Fed,” that money place people are always talking about, do anything?
In Europe, the “Fed” is the European Central Bank. The ECB could theoretically buy up Greek and Italian (and other debt) with printed euros. This would devalue the currency and allow these countries to pay back their debt with cheaper euros. It’s inflation, and it could be the only way around the EFSF’s political gridlock. Unfortunately, this tactic is by all accounts anathema to the ECB leadership and Germany. For now, at least, it’s off the table.
However, on Wednesday the world's central banks — the Federal Reserve, the European Central Bank, the Bank of Japan, and the central banks of Britain, Canada, and Switzerland — made a surprise announcement that they would work together to make it easier for troubled European banks to access money, which bankers like to call "liquidity." This made the stock markets really, really happy, although it doesn't fix any of the underlying problems.
So is Germany going to bail on the euro and go back to using douche-marks?
It’s pronounced — never mind. A country like Greece may eventually decide that leaving the euro is the best of many bad options, but for now it doesn’t appear as if countries are going to leave the euro en masse and return to their own currencies. That said, there is no mechanism in the euro treaties for countries to leave, so there is some uncertainty about what happens when a country does leave. Rest assured, when that happens there will be bountiful pictures of traders with their heads in their hands.
What happens next?
The frantic pace continues. Markets may continue to punish Italy with higher interest rates, making the situation, somehow, more serious. Meanwhile, European leaders are holding regular meetings to settle on Greece’s latest round of bailouts and hammer out a possible expansion of the EFSF. The IMF has discussed wading into this mess with loans or loan guarantees of its own. EU leaders are also meeting next week to discuss a larger proposal of rules that would govern its economic future.
Okay. If I understand this all correctly — and I think I do — what you’re saying is that the cast of the Jersey Shore got out just in time.
These conversations are never worthwhile.