A plan to save the Euro - Number 4113

 

The President of the European Central Bank has announced a new plan to save the Eurozone. It's well overdue and just the latest in a long running problem.

The Euro as a currency is in trouble because some of the members economies are very weak. This includes countries like Greece that have crippling debts and Spain who have 25% unemployment as a result of the economic downturn.

Confidence in the Euro is low which has led to the exchange value of the currency falling. There are also worries that some Euro area countries cannot pay their debts and so when they try to borrow more money they pay very high interest rates as the risk to lenders is high. This is making an economic recovery very difficult.

The new plan allows the European Central Bank (the ECB) to buy the bonds issued by countries that are used to raise the money they need. This will help fund their spending if they are new bonds. But more likely the ECB will buy old bonds. Whatever method is used in doing so the price of the bonds will rise.

The price of a bond and the rate of interest paid move in opposite directions (they are inversely related) and so the Euro area countries should find themselves paying lower interest rates on their debt. This will reduce pressure on their budgets, allow them to spend more and tax less and hopefully boost economic growth. It will also let households and firms borrow at lower rates, boosting Consumption and Investment.

This move has been bitterly opposed by the Germans, who think that basically it means German money buying other countries debt. But the move is long overdue, although possibly far too late.

The Independent report the plan here

Understand the Greek crisis?

It's ok, nobody really understands the Greek crisis, and few have a  clear idea of what will happen next.

The Guardian have done a handy interactive flow chart where you can explore the possibilities.

The Guardian flow chart is here

Saving the Euro or just delaying the inevitable?

I can't do justice to this subject in a post. The Euro crisis has so many issues and aspects. But the agreement reached yesterday is certainly important and adds to the story in a way that does sum it up to an extent.

The Euro area countries have agreed to

* Cut by half the amount Greece owes the banks (reducing their total debt and so not only the amount they will repay but also the annual interest).
* Recapitalise the banks so they are better able to withstand further shocks (say a default by Italy or Spain)
* Increase to €1 trillion the bailout fund available in case of potential default.

The markets love it and have soared, but should we be so sure?

The French President stated that 'Greece should have never been allowed to join the Euro' because they were not ready and falsified the figures. Well he is probably right and the fact that the Euro area is not an 'optimal currency area' has not gone away. Maybe this isn't the time to say France 'managed' the figures too to meet the joining criteria, but it is certainly true that Belgium and Portugal should not have the same currency.

The 'partial default' that the 50% cut in Greek debt represents is a managed way to prevent a full default. That would cause panic and probably the break up of the Euro area. That would be disastrous for trade - what does anyone do between the Euro and the 'new' currencies that would replace it? Months of lost trade, shutdowns and unemployment would be inevitable and that would affect the UK too, with 60% of visible trade done with the EU.

As one commentator said. 'What the Eurozone needs is growth'. This will solve many problems. The debt to GDP ratio will fall, and governments will have more revenue and lower expenditures, allowing them to service their debts. Growth will also allow confidence to return and the growth will become self-sustaining.

But the recapitalisation of the banks will slow growth. For banks to have more capital they have to keep more of their assets, and that means lower lending. Lower lending leads to a credit squeeze and firms can't get the capital they want. Interest rates will probably rise as firms demand more loans and the price rationing process kicks in.

Perhaps the most worrying aspect is that €1 trillion is nowhere near enough to bail out Italy let alone Spain and Italy together. The Euros inherent weaknesses remain and in all probability this is just a temporary lull in the crisis.

The BBC covers the issue here

Greece! Should the euro stay?

Increasing the British government is becoming sceptical about Greece's ability to pay back its' public debt and has not attended the latest bailout meetings. The issue is: Can Greece be saved and is it worth saving? Few doubt that the failure of Greece will lead to lower growth in the Euro region (where over half of the UK exports are sold). However the bailout seems to be increasingly viewed as a simple delay tactic and that defaulting on the debt is unavoidable.

http://www.guardian.co.uk/politics/2011/jun/20/treasury-minister-faith-in-euro-falters