By: Elmé Naudé
To understand the crises that Greece and the rest of the European Union find themselves in, there has to be an understanding of how the EU existed and why. 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 told banks that all bonds from the Euro zone were identical whether it be from Greece, Italy or Spain. So banks rushed to lend money to the weaker Euro zone countries, borrowing costs plummeted and currently countries like Greece and Italy are finding themselves with an overdraft on their debt.
Greece has unsustainable levels of public debt and thus they have borrowed money from other European countries and the International Monetary Fund (IMF) in order to avoid default, this puts Greece at the center of the crises in Europe. So what was the buildup to the crisis? They had abundant access to cheap capital, fueled by flush capital markets. Capital inflows were not used to increase the competitiveness of the economy, however, the European Union (EU) rules which were designed to limit the accumulation of public debt failed to do so. Furthermore the 2008/2009 financial crisis strained public finances and falsified statistical data drove up Greece’s borrowing cost. With an enormous public debt, a credit downgrading followed in 2011 and that is when the crisis struck. Investors started losing confidence in Greece and more countries started pulling investments from Greece. Some might argue that policy responses had limited to no success with financial assistant packages from the European Central bank and IMF in 2010 which only helped temporarily. A year later Greece was again contracting sharply heading for default. In 2011 a second set of responses was launched where holders of Greek bonds had to accept losses, as well as more austerity. Because Greece is part of the Euro zone they cannot depreciate their currency to spur export led growth. This crisis raises the issue of broader implications such as the problems of a common currency combined with national fiscal policy. This highlights the concern with the health of the European financial sector and how contagion affects countries like the United States and China which is leading economies in the world. United States exports to the EU could be impacted if the crisis slows growth in the EU and causes the euro to depreciate against the dollar. Worst case for Europe the whole Euro zone breaks up and major shifts will have to be done, every country will have to go back to their own currency with their own lending rates and every aspect of bank finance. The European Central Bank (ECB) will have to disband. Because Europe is an developed country, this would mean less confidence in developed countries and maybe more investment in emerging countries.
This begs the following questions. Should Greece leave the Euro Zone and what will happen? How will the Euro Zone breakup impact the rest of the world? And the big picture: Is this not a warning for Africa and the consideration of an African Union currency?