It feels as though the world economic crisis has been going on forever, doesn’t it? . In a way it has – and still no end in sight. Many of us will remember previous recessions. Governments cannot seem to figure out how to break the Boom & Bust cycle. The question of balancing the books is a little like driving – apply too much accelerator (spending) and inflation spirals out of control. Too little (low interest rates) or too much braking (higher taxes), and your vehicle stalls, eventually shuddering to a halt, or even rolling backwards (recession). Governments don’t have brake and accelerator pedals. They use a mixture of controls – interest rates, exchange rates, taxes, bonds, gilts – all are borrowing and selling money in various ways.
Since the formation of the single currency, the Eurozone countries have lost their individual controls. They are all in their own cars, but the pedals are now operated centrally. But as all the cars are travelling at different speeds, the controls aren’t so effective. And if one country – such as Germany – decides the brake pedal (austerity) is the way ahead, it stops others using the accelerator (growth) to regulate the speed at which their economy is moving. This means that the competitiveness between all the EU cars (countries) is no longer fair, as they cannot choose their own route.
A simplistic analogy? Maybe, but I’m no economist, and I like things simple! Too often, currency analysts and City economists will indulge in complex jargon. One of the best explanations of the Eurozone crisis I have read is from George Soros – he is an American economist and billionaire investor. He made a speech recently, summarising the situation. I reproduce here the excellent translation by National Public Radio of his speech into simple language:
Before the euro was introduced, governments in Greece, Spain and Ireland, among others, had to pay a lot more to borrow money than governments such as France and Germany. But after the euro was introduced, there was this amazing convergence. Suddenly, all the countries could borrow at the same rate.
European officials essentially told banks: Bonds from all euro zone countries are identical. It doesn’t matter whether they’re sold by Greece or Germany or whoever. They’re all the same. So banks rushed to lend money to the weaker euro zone countries, and their borrowing costs plummeted.
For roughly a decade, it seemed that the dream of the euro was coming true. Borrowing costs were almost identical for all of the countries in Europe. But under the surface, Europe was actually growing apart.
Germany got better at selling goods to the rest of the world over the past decade. Other countries in Europe had a false sense of prosperity. They borrowed lots of money to buy goods and build houses, and they got worse at selling goods and services to the rest of the world.
The euro also made it easier for Germany to sell stuff to countries on the periphery of Europe, both by making German goods cheaper for people in those countries, and by making it easier for people in those countries to borrow money to buy stuff from Germany.
After the financial crisis, it eventually dawned on everyone that the countries that shared the euro are, in fact, a bunch of different countries, with vastly different economies — and that, despite what the officials said, not all Eurozone government bonds are identical.
Once everyone realized that some Eurozone countries might not be able to pay back their debts, they started demanding higher interest rates to lend to weaker countries. That, in turn, hammered the banks that had loaned all that money to those weaker countries.
Those two, related problems — rising borrowing costs for weaker countries, and trouble for banks that have loaned money to those countries — are at the core of the European crisis.
Will the Euro break up? If it did, it would be very bad for Germany, which is why, Soros says, they will try to save it…. The end of the euro would hurt Germany in two main ways.
First, it would mean Germany’s central bank would never be able to recover a huge amount of money it is owed as part of Europe’s current system.
Second, the end of the euro would make German exports much more expensive in the rest of Europe. That would be a big blow for a key part of Germany’s economy.
The deep problem facing the euro zone isn’t just debt. It’s the vast gap between the economies in the struggling countries and the economies in the stronger countries. If Germany does the bare minimum to keep the euro afloat, those differences will persist — and the struggling countries will continue to struggle indefinitely.
Soros argues that Germany should do more than the bare minimum, to try to change the broader economic picture in Europe. But he says that’s not likely to happen.
To learn more from National Public Radio, check out their website at NPR.org
[Copyright 2012 National Public Radio]
And if you would like a no-obligation discussion on how First Rate FX could help you move your money to or from the Euro, whether for business or for your own personal finances, contact us via judym@firstratefx.com, quoting Normandy InSite magazine.
Thank you for your article Judy. I really appreciate both yours and George Soros’ explanations and views…in English, as opposed to financial terms