THE EUROZONE CRISIS

EUROPE BEFORE EU
The European Union is a geo-political entity covering a large portion of the European continent. It is founded upon numerous treaties and has undergone expansions that have taken it from 6 member states to 27, a majority of states in Europe.

Pre 1945
Large European areas were previously unified by empires built on forces such as:
Roman Empire Byzantine Empire Frankish Empire Nazi Germany etc.

Due to devastations caused by wars the idea of a unified Europe was seeded. (Western Europe post WWI) The real steps however were taken after the WWII

World War II 1939-45

WWII hit the hardest economic and human cost to Europe Demonstrated horrors of war and extremism through Holocaust and Hirohsima & Nagasaki attacks With the war giving the world nuclear weapons the countries of Western Europe failed to maintain their Great Power To ensure perpetual peace
heavy industry in Germany was partially dismantled Main coal producing results detached(Saarland)/put under international control(Ruhr Area)

1945-1957
Post WWII call for United States of Europe become louder under the guidance of Winston Churchill 1950: Integration of coal and steel industry of Europe by French Minster-Robert Schuman 1951: Treaty of Paris signed by Benelux with West Germany to create European Coal & Steel Community 1957: Treaty of Rome signed after failed attempt to create defense and political communities The Treaty of Rome gave rise to the European Economic Community(EEC)

1958-1972
Rise of Communities
European Economic Community (EEC) to develop customs union. Atomic Energy Community (Euratom) to integrate sectors in Nuclear Energy Merger Treaty of France to merge the 3 communities was signed in Brussels creating European Communities

1973-1993
1973: Denmark Ireland Gibraltar UK joined 1979: first direct elections for European Parliament 1981: Greece joined after 6 yrs of applying 1985: Greenland seeked exit 1986: Spain and Portugal joined 1887: Turkey applied to join to be the longest applying country 1989: East and West Germany reunite With all the new enlargements Maastricht Treaty was signed on 7 February 1992 which established the European Union when it came into force the following year in 1993.

FORMATION OF EUROZONE

Establishment of eurozone
It was an extremely complicated and challenging event in 1929 in the League of Nations, Gustav asked for the formation of an European currency due to the number of new nation states in Europe after WWI France, Italy, Belgium and Switzerland Disintegrated following the First World War

Cont
A first attempt to create an economic and monetary union between the members of the European Economic Community goes back to an initiative by the European Commission in 1969 Meeting of the European Council at The Hague in December 1969. Council tasked Pierre Werner, Prime Minister of Luxembourg, with finding a way to reduce currency exchange rate volatility between member nations He made policies entailing the total and irreversible fixing of parity rates and the complete liberation of movements of capital. His report fell short of proposing a single currency or central bank.

Cont
The resulting widespread currency floats and devaluations set back aspirations for European monetary union. However in March 1979 the European Monetary System (EMS) was created, fixing exchange rates onto the European Currency Unit (ECU), an accounting currency, in order to stabilize exchange rates and counter inflation. It also created the European Monetary Cooperation Fund (EMCF). However, there was still much work to be done before the Euro became an everyday currency.

Cont
The Delors report of 1989 set out a plan to introduce the European Monetary Union (EMU) in three stages. It included: The creation of institutions such as the European System of Central Banks (ESCB), which would become responsible for formulating and implementing monetary policy. It laid out monetary union being accomplished in three steps. Beginning the first of these steps, on 1 July 1990, exchange controls were abolished, thus capital movements were completely liberalized in the European Economic Community. Leaders reached agreement on currency union with the Maastricht Treaty, signed on 7 February 1992. It agreed to create a single currency, although without the participation of the United Kingdom, by January 1999.

Advantages and disadvantages

Diverse microeconomic benefits Money is more useful when it is used over a wider area evidence that intra-Eurozone trade in goods and services has already risen by 5-10% on average Higher cross-border mergers and acquisitions have led to restructuring of capital within the same sector of activity thereby raising efficiency

Benefits of improved macroeconomic stability

The ECB is highly credible, and inflation in most Eurozone countries has never been so low. Moreover, inflation expectation has remained well anchored since the launch of the euro, and even during the ongoing financial crisis. This has been instrumental in securing the lowest interest rates on a two-, five-, ten- or even fifty-year basis Over the last decade average per capita growth in the Eurozone and the US were very similar GDP growth rates of high performing Eurozone countries were even higher than most adjacent nonEurozone EU countries.

Costs from adverse external effects

An old issue is the loss of direct control of part of national foreign exchange reserves and other assets that are transferred to the newly established central bank. This cost is mitigated by the fact that joint reserves may have a proportionally higher bearing. From the standpoint of fiscally disciplined countries with stable legacy currencies, there are adverse effects if other members run sizeable and uncontrollable budget deficits, and accumulate unsustainable debts. Again the remedy lies in strengthening fiscal governance

THE CRISIS UNFOLDS

THE BEGINNING OF THE CRISIS

Unprecedented in post- war economic history Similar to previous crisis episodes except the global dimension related to the current crisis

The crisis of 2007 lead to

Uncertainty amongst banks about the creditworthiness of their counterparts The interbank market virtually collapsed, loan risk premiums soared Rise of liquidity problem in European Union Short sighted view of policy makers about financial markets

CONTINUED
The fall of Lehman brothers changed perceptions

Panic broke across financial markets

Market valuations plummeted

Investors rushed to safe havens

Banks forced to restrain credit

Economic activity plummeted

Loan books deteriorated

SNOW BALLING EFFECT

Banks cut down credit

ECONOMIC GROWTH RATES

AUSTERITY MEASURES BY SUPRANATIONAL AUTHORITES

GLOBAL FORCES BEHIND CRISIS

Property bubble in US

Net Saving Surpluses of China and Japan

1
2 3

Upward pressure on vs. $

Carry Trade leading to spillover of liquidity in EU Large Capital Flows due to integrated Financial markets

Strong Expansion in Labor Forces in emerging countries

IMPT

Rescue Measures taken by

ECB, IMF ESM, EFSF to overcome crisis.

Measures

The European union , the IMF & the ECB set up a tripartite committee (the TROIKA) to prepare an appropriate programme.

First round of crisis response (May 2010 ): 3 years package of 110 billion ,Contributed by IMF ( 30 billion) and Euro zone ( 80 billion). ECB provided substantial liquidity support to Greeks private banks [b/w Jan 2010 to May 2011 51 billion. Again Euro zone provided loan - July 2011 109 billion.

Measures
ECB starts buying govt. debt from secondary market to reduce bond spread and to increase the confidence of investor . Between May 2010 to June 2011 ECB purchased 78 billion bonds ,out of which 45 billion from Greece govt.

Measures
EFSF(European Financial Stability Fund ) : The EFSF is intended to consist of a fund of 750 billion, which would be made up as follows: (a) 440 billion would be made available in loan guarantees from Euro zone Member States; (b) 60 billion would consist of emergency funds made available by the European Union itself; and (c) 250 billion would be provided under arrangements with the International Monetary Fund.

Measures
EU also made a proposal to make a single authority responsible for tax policy and govt. spending. Austerity measure are outline in Feb 2010 (1st austerity measure) aimed to reduce government budget deficit to 3% of GDP by 2014. Freeze in the salaries of all govt. employees. 10% cut in Bonuses & payment of overtime work. 8% cut in public sector allowances .

Measures
2nd Austerity Measure :[May 2010]
30% cut in Christmas & leave for absence. Further 12% cut in Bonuses & 7% cut in public and private employee Increases in VAT[10%] - 23%(goods & Services), 11%(Food) and 5.5%(stationery). Return of a special tax on high pensions. Equalization of men's and women's pension age limits. A financial stability fund has been created. Average retirement age for public sector workers has increased from 61 to 65.

Measures
3rd austerity measure:[Jan2011]
Further cut in salaries by 8% for public employee. The 13th and 14th salaries paid to civil servants and public utilities employees were abolished & flat-rate vacation allowances totaling 1,000 a year were introduced for public sector workers earning less than 3,000 per month. Limit of 800 per month to 13th and 14th month pension installments; abolished for pensioners receiving over 2,500 a month. 10% rise in luxury taxes and taxes on alcohol, cigarettes, and fuel.

Bailout plan
European 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 off financial meltdown. The 27 countries of the European Union (EU) will contribute 500bn Euros towards 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 from the 16nation Euro-zone bloc, which is promising 440bn in loan guarantees. The European Commission 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 Eurozone. 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 Greece

Greece has outlined plans to cut its budget deficit, or the amount its public spending exceeds taxation, 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 of austerity measures already taken.

CRITIC ON THE STEPS TAKEN & POSSIBLE SOLUTION

Although everyone is clamouring for an elegant solution possible construction of a viable plan to address the issues in the Euro zone will be mired in complexity

POSSIBLE OUTCOMES
AUSTERITY PACKAGES SPENDING CUTS FEDS INTERVENTION FALL OF EU

ROAD AHEAD:
STABILITY UNION CONDITIONAL BONDS FISCAL SOLUTION FEDS INTERVENTION GOLD BACKED SECURITIES IMFS POLICIES ADMINISTRATIVE DISCIPLINE GRAND BARGAIN

CONCLUSION