The Causes and Possible Future Outcomes of the European Debt Crisis

Subject: Finance
Pages: 16
Words: 4375
Reading time:
17 min
Study level: PhD


The economic and financial crisis in 2008 and 2009 considerably affected both the emerging and poor economies around the world. In 2008, worldwide industrial output decreased by 20 percent, while developed and emerging economies’ output fall by around 24% and 14%, respectively (Blundell-Wignall, 2012, P. 4). Uncertainties of a sovereign debt crisis around the European countries developed at the end of 2009 since it became apparent that it is hard or impracticable for Spain, Italy, Portugal, Ireland, and Greece to pay back or refund their loans to eurozone bodies and institutions. The banks and other sectors, including major countries, were lending to Portugal, Italy, and Greece at similar rate as they offer to Germany even in the most modern years of 2008, expecting that Euro would be unified forever and all countries in eurozone were very secure like other countries such as Germany and France. Consequently, for example, Greece collected around 145 percent of its GDP as gross debt above its own output (Gross Domestic Product) in roughly two years.

In this paper, it will first discuss the history of the Euro, the requirements to join the European Union, and the number of countries that are in the European Union (EU). Second discussion addresses the impact of credit crunch among European countries and the problems associated with this crisis in some countries in EU. Third, it also discusses Germany’s interests regarding the debt crisis. Finally, the paper provides some major impact of the debit crisis in European countries and the rest of the world. Some solutions are provided in the paper that these countries have or should follow to solve the issue, as well as recommendations and conclusions.

The History of the Euro

The European Union (EU) was formed through unification of different states that came together to form an economic and political society throughout European region. EU is made up of 27 member states, has a rich history and an exclusive organization that helps to attain its present achievement. It also aids to gain sufficient ability to accomplish its mission for the 21st Century (Wihlborg, Willett, & Zhang, 2010). The originator of the EU was formed after Second World War in the end of 1940s with the intention to put together the European countries and stop the war era that existed among neighbouring countries. These countries started to unite formally in 1949 with the Council of Europe and the formation of the European Coal and Steel Community in 1950 aided in developing the union. The Netherlands, Luxembourg, Italy, Germany, France, and Belgium were the only countries that participated in the first accord, and these nations are called “founding members” presently.

The Cold war, separations, and protests that occurred in 1950s called for more unification, and the Treaty of Rome was passed to strengthen this need for unification in 1957. Therefore, this formed the European Economic Community and enabled people and commodities to get a free passage through borders of European countries. More countries were allowed to join European Union throughout the decades. In 1987, the Single European Act was signed to extend the unification of Europe, which later brought in a “single market” to support trade (Buttsworth, 2011). Additionally, the unification of the removal of boundary (Berlin Wall) between western and eastern nations promoted the alliance.

Requirements to Join the EU

There are various mandatory requirements that any interested country must attain so that they can join the European Union and become a member state. The first essential condition addresses the issue of political position. Another issue governs the market economy that every interested country must portray that it is adequately strong to support itself inside the competitive and demanding EU marketplace.

Finally, an entrant country should be interested to follow the goal of the European Union that focuses on the financial, economic, and political matters. This union also wants that all countries must be ready to participate and follow established judicial and administrative systems of the European Union (Stein, 2011, p. 204).

When the candidate country has proven that it has attained all the conditions needed to be member state, the country is monitored. If the country is accepted, both the country and the EU will sign a Treaty of Accession that passes through rectification, approval, and further discussion from the European Parliament and European Commission. After these defined procedures, the country is allowed to be part of the union or become a member state.

The Impact of the Credit Crunch

The credit crunch has been deeply analysed throughout the globe, and currently experienced by several countries around the world. Europe has been participating in investments in the American banking system, but currently falling along with it.

The credit crunch experienced in Europe has brought worries concerning financial prospects, families and investments. Most people in Europe have been feeding on credits that are actually over their incomes for a long time, and currently credit is difficult to find. In the past years, subprime loans were adequately made available, which brought in huge and admirable income to the banks that received high interest rates and initiation charges. Later, these banks trade off the loans to potential investors. Certainly, such investments are just profitable or viable if interested people follow through and repay the loans to the banks. Frequently, the borrowers find themselves in default that basically left the banks with minimum money to give out to the borrowers (Dadush, 2010, P. 103).

Outside the investments that European banks have contributed in the American financial system, they have also given out money to various banks in America. Those American banks are receiving aids from their government through financing them to prevent these banks from falling down.

Global banking structures are fighting back not just due to their private activities, but due to the activities taken by partners in the business environment as well. Even developing and under-developed countries are experiencing the impact of the credit crunch dripping from developed countries in the United States and Europe. The time of isolationism and safeguarding yourself from the collapses or failures in different places in the globe do not exist anymore. Currently, the world is reliant on exports and global businesses that influence the open market in even the minor economies around the world (Duthel, 2011, p. 121).

The governments have stepped in to solve the issue of credit crunch through financing banking systems, but to this point the crunch has not been fully eliminated or eased. It is expected that an improvement in the global economy might undergo delay to happen or be experienced.

Problems in Greece

Debt issues in Europe began in Greece in 2008 and financial problems there have not been solved completely. Greece is nearly settling a deal with private creditors to record a part of the overpowering debt crisis. Greece has fought back to satisfy the standards of its bailout loans lately and different eurozone countries remain unwilling to give more funds without guarantees. Greece declined the idea as a violation of national sovereignty, and other European Union executives have excluded it. The threat is that Greece will not gain on the €14.5 billion bond recovery without extra bailout funds, which might bring out an unruly default, a progress that would have the unkind and incomprehensible impact for the worldwide financial structure (Hunter, 2011, p. 35).

Various nations in the eurozone have loaned and use too much because of the worldwide recession, mislaying management of the finances. Greece was first country to obtain a multi-billion pound bailout from other troubled nations in Europe in mid 2010, which Ireland and Portugal followed (Eubanks & Cape, 2011, p. 597). Their governments had to comply with spending cuts so that it can allow the loans to be permitted or approved, but currently, with the Greek parties who agreed on the proposal incapable to create a government, there are concerns that the rescue preparation might be unsuccessful and the nation might depart the euro, igniting instability in European Union countries.

Most Greek citizens do not want any extra tax increases and employment losses in the public companies, but strong spending plans have been enforced with the intention of making the government to obtain billions in bailout finances. Different protests on various parts of the country as well as strikes at power stations were reported. This has brought about most people to go out without any electricity in some parts of the country, and Greek parliament agreed on more tax increases and spending cuts during the end of 2010 (Buttsworth, 2011, p. 24).

If Greece has the minimum powers or reluctant to continue paying the money they borrowed from various countries in Europe, the country may indeed find itself bankrupt. This would create life at Greece even harder for the citizens who may feel poorer than before as their money may become less valued compared with the past years. Governments in other EU member states, such as Portugal and Ireland, must pay more so that they can borrow money and could have to increase taxes and reduce total spending to stabilize the situation.

The United Kingdom has not participated in the bailout in Greece since it is not part of the euro, but it contributed through its involvement in the IMF, which funds several countries all over the globe. However, different British banks have loaned money to Greece and might lose large amount of money if Greece would become bankrupt. The country might lose more money if the same issues are experienced in many countries, such as Italy and Spain (Stein, 2012, p. 151). If banks undergo severe experience, there could be an example of another unwanted credit crunch that creates it harder and complicate for British residents and companies to borrow money for mortgages and loans. Businesses in the United Kingdom perform several trade transactions with companies in several countries around Europe.

Public debt as percentage of GDP from 2007 to 2010
Figure 1: Public debt as percentage of GDP from 2007 to 2010

Problems in Portugal, Spain, and Italy

The rescue plans of around $125 billion that was provided to banks in Spain shifted Italy to the top position in the debt crisis in Europe, and Italy has a debt of about two trillion euros that contribute mostly to its economy over any country in Europe, apart from Japan and Greece (Young & Semmler, 2011, p. 78). The Treasury decided to trade above 40 trillion euros of bills and bonds every month, which is above the yearly output of all three smallest EU affiliates (Malta, Cyprus, and Estonia). The Spanish government revealed that it will apply for more than 100 billion euros as emergency loans from the eurozone to support or enhance banking structures that have been affected by above 200 billion euros of awful assets. Rising worries about the condition of Spanish public finances and banks made the Spain’s borrowing expenses to be close to euro-era records and created Italian rates to go up during this activity.

Italy is on course to make its budget deficit to comply with the EU standard of three percent minimum based on GDP and currently running a surplus ahead of interest payments, which signifies that Italy’s debt will max out rapidly at around 125% of Gross Domestic Product. The unemployment rate is below 50% of Spain’s 24%, and Italy did not undergo a real estate bust, making its banks fit for the SE values and conditions. The budget deficit was 4% of Gross Domestic Product in 2011, which was below 50% that of Spain (Canstancio, 2012, p. 34).

Italy’s debt issues had usually made the country to be picked out as a larger credit risk compared with Spain. At the beginning of 2011, Italy’s decade bond produced 200 points above the points obtained by Spain. As the degree of despairs in Spanish banks become more apparent and the nation was enforced to increase its deficit goals and Spain’s 10-year produces 50 points above Italy’s points.

The financial crisis of 2009 is influencing Portuguese financial status harshly, bringing about a broad range of internal issues particularly involving the extent of public deficit in the country’s financial status or economy and the extreme debit heights. However, the government undergoes hard options in its efforts to rouse the economy, whereas trying to sustain its public deficit around the European Union average. In mid 2011, Portugal revealed that it will request a financial bailout from the EU that will be around 80 billion euros, as they follow Ireland and Greece. It has been expected that the Portugal’s economy will not considerably get better until 2013. Italian rate of seven percent is considered by most investors as unsustainable. Italy now appears to be stacked in a downward spiral. If nobody will lend to Italy, it cannot repay its debts and if Italy cannot repay its debts, it means that nobody will lend to it.

German Interest

Some key banks in Germany were supported by the eurozone currency union to avoid bankruptcy and the country’s taxpayers from the load of an enormous rescue. The experience of the European banks to the PIGS was not selfless economic growth and cooperation finance, but it was always exploratory and lacking outstanding, careful investment. Additionally, Germany depends on the European Union for exports and signifies that a steady and not undergoing recession is not on its concern (Howden, 2011, p. 26).

Bundesbank (German central bank and government) are passionately opposing the opinion and do not feel like paying superior interest rates. Certainly, German leaders stated that treaties of European Union outlaw joint debit liabilities, and the country’s constitution would require to be changed, as stated by other leaders.

Impact of Euro Instability

Most economies in the world have been experiencing the eurozone crisis and more recently, European debit crisis has an impact on the inner economies in the EU member states. The European Union makes up around 25% of the global GDP (following the market exchange rates) and the 20% is brought in by eurozone. The euro region makes up around 10% of the world equity market income and the euro makes up around 25% of the allotted world holding of reserves (Blundell-Wignall & Slovik, 201, p. 12). Therefore, the implication of this debit issues is not just that it comes in the outcomes of the world crisis, but significantly poses some risks on the improvement rate of the world economy particularly on the European Union. Moreover, due to this issue, the eurozone is a major market for most countries in the globe.

The higher the European instability goes on in the eurozone, the higher the effect will probably be on the gold prices, and other major commodities in the world, which will certainly move upwards. Currently, most investors are going away from European bonds and spend or invest in gold as an alternative. Derived from earlier performance, an expectation of $2,200 for 2012 does not appear like unrealistic prediction, but with several aspects and the eurozone continually aggressive for recovery, the costs of precious metals are away from expected condition.

The sovereign debt crisis in the minor economies of the eurozone has began to create a severe risk to the major economies in Europe and possibly to the prospects of the euro itself. This severe condition is a far cry from the grand vision and expectation that marked its start or commencement.

If the eurozone debit crisis continues to worsen, it can considerably affect the economies of the developing and underdeveloped countries around the world. Several developing countries are probably to evade reductions in output observed in developed economies and are substantially more sustainable to an economic hold back. Key channels for a transformed financial crisis to affect the developing and underdeveloped countries in the world directly include decline of market capitalization, Diaspora remittances, and commodities or minerals exports that build most economies in the globe.

Several major countries in the world have offered huge debt to Greece and if the country fails to pay these debts, this will contain serious impact on these countries and other economies. Most likely, other countries or economies would fail to pay or default on these debits as well. The banks of the countries that offered support and loans to Greece will experience great liquidity crunch and the people involved will undergo enormous credit crunch where they would not have the capacity of borrowing money. This would bring about low output, minimum development, decreased trade, and a condition resulting in worldwide economic recession (Kolb, 2011, p. 389).

Solution Provided by EU

The European leaders lengthened the demands on Europe this year to raise a more formidable wall of funds against the sovereign debt crisis, cautioning that the Europe debit crisis goes on to pose a cruel risk to the worldwide economy.

The agreement revealed this year does not actually emerge to be a major advancement and the most important being that EU authorities eventually appear to identify particular facts. These facts include the point that Greece is incapable of paying back its existing debits, the European banking structure requires more and efficient quality capital, and there are necessities to be a realistic with financed backstop to end infectivity in all markets.

European countries have an appreciation that these are major issues, as well as a reputable readiness from authorities to maximize the plate in a serious manner. The projected hairstyle for debt existing in Greece is 50%, which was formerly 20% and with a larger bailout finance accompanying it (Lynn, 2009, p. 98). The Greece banking system is to be enhanced by around €105 billion to 10% and the recovery fund is to be increased from the outstanding €260 billion of the initial €450 billion to above € 1.2 trillion to the same banking system (Grobys, 2012, p. 68).

Through the past events, European leaders have attained some relieves due to the emergency money that the European Central Bank has invested or provided to the banks in Europe, a process that has eased markets. European Union leaders are more concentrated on addressing what they observe as more instant threat of Greek default, and less on examining taxpayer’s tolerance through raising the amount of the firewall.

The Objections of a Eurobond

The partial divide set provides a possible benefit for both Northern and Southern nations in Europe. Feeble economies like Greece would be unchained from the microeconomic hindrance of the Euro, allowing a comeback to the currently undervalued national currencies to rouse Gross growth. Sturdy economies like Netherlands and Germany would be reassured from the requirement to subsidise economically decadent nations in Southern Europe. A reduced eurozone would perhaps endure and gathered inside sensibly controlled Northern European economies adjacent to the former vision of the Economic and Monetary Union.

One major objection to the concept of euro bonds is that Germany would be ensuring the Greek debt, as well as other cross-country subsidies between the inner and the border around the European states. In different discussions concerning euro bonds, it is always stated that they would promote nations with higher debts at the cost of nations with lower debts. However, the latter would experience a superior risk premium on their debt because the assurance they offer to some nations would place an anticipated burden to their financial plans (Candelon, 2010, p. 87).

On the surface, Germany’s major objections appear apparent and include the point that it would locate Germany on the clip of huge debts of southern European countries that are inside the misery. This will also increase the cost of borrowing in Germany and would decline the incentive for nations like Greece and Italy to place funding on course if they will understand they may benefit from creditworthiness that Germany possesses.

Ways Forward

The ECB is often carrying out small and fictitious Euro bonds and trading with every European Union affiliate that must be sanitized on each function with repo functions. However, the latest ECB permanent refunding functions cannot disappear everlastingly. Some people would ask if Greece will voluntarily or forced to exit the eurozone. Euros can often continue to be produced or printed, but operations would be less difficult if the Euros are supported by Euro bonds. If currently the investors are more interested regarding solvency than liquidity, the support by the ECB may be of less importance to the eurozone. Full-scale quantitative reduction will be required and is absolutely more efficient with Euro bonds, which this means that monetising European Union sovereign debt instead of monetising national debt (Olivares-Caminal, 2011, p. 8).

There are several ways of ending Greece’s membership in European Union or eurozone and include the process of being forced to quit by the European authorities, or the second option is allowing Greece to leave voluntarily. It appears that neither of this processes attached to Greece are ready to be practised by both parties. Meanwhile, rules or treaties are not present in the European Union for the cessation of certain membership in the euro society, but these processes have a risk of destroying the harmony in the euro community.

Most people propose that Greece has to leave the eurozone willingly with the intention of resuming sole power over its financial policy to prevent and reduce the latest crisis that has closely overwhelmed them. Some analysts even quote the instance of Argentina that after experiencing serious monetary problems in around 10 years ago, it drifted off the currency board, an inflexible global exchange rate structure, and left the crisis rapidly through devaluing the peso to promote or rouse exports in the country. Adapting the practicable alternative shown in Argentina, Greece is a Southern European country that does not have the adequate commodities to sell to the world marketplace even if it decides to leave the eurozone.

Additionally, if it would decide to leave or forced to depart the eurozone, Greece would absolutely experience a financial disaster as capital would diminish in the nation and most banks would undergo bankruptcy (Rothenhöfer, 2011, p. 45). Therefore, exist has the high possibility than all other options in solving this Europe debt crisis. If Greece, or other country undergoing the same challenges, follows this process, it should move rapidly to restore the drachma. This enables the market to reconsider the prices of commodities in Greece so that they can compete in the global market and improve the country’s economy.

Moreover, the European Central Bank has become part of the solution and crisis, even though it is declining the alleged “bazooka” choice of printing money to purchase the European severe debt. The ECB revealed a proposal in last year to buy government bonds if essential with the intention of keeping yields from strengthening to a level that nations like Spain and Italy could not manage to pay for it. At the end of last year (2011), the ECB provided around €490 billion in credit accessible to the banks that have the same problems. Several financial sectors were supposed to pay off their debts by 2012 and brought them to uphold reserves instead of increasing loans. Somewhat, sluggish loan growth could affect the economic development and create the debt crisis even worse, whereas the activities of ECB did not resolve the inner of European crisis, which relates high government debt. However, the investors proposed ways intended to support and improve the EU economic issues (Mody, 2012, p. 251).


Europe region should keep a flexible monetary policy that errs on the section of development for a lengthy time and openly to support feeble euro. Europe regions should allow countries to concede certain financial self-rule. It should provide EU member states the privilege to assess other members’ yearly budgets and major economic indicators, for example the balance of payments, production development, and growth of GDP. They should enable European governments, including the IMF and European Commission, to consider, recommend, and assess actions provided by the GIIPS as they adopt suitable and practicable sanctions. They should stiffen the condition for approval to the Euro region and should allow beginners to control big financial surpluses to balance the demand boom that usually goes with euro approval. They should not need one size to fit everybody, but reflect on repeated and structural indicators in all economies and countries. Implement conditions that active EU member states and candidates will assess regularly and are dependable they should provide equivalent data on the economic or microeconomic indicators, such as GDP and unemployment indicators.

Greece government should reflect on reforming the debt and enabling time for creditors to be ready to support development on a decided solution. The country should prepare for a huge reduction in jobs and earnings, probably bigger than predicted irrespective of the manner the crisis is determined. Greece should also depend mostly on exports and embark on measures, such as promoting wage decrease in both public and private sections, to reinstate competitiveness regardless of political difficulties. If development on reinstating competitiveness is not attained inside a sensible period, Greece should consider leaving the eurozone and will signify restructuring the existing debt.


Generally, European countries are not greatly indebted and if they team up, they should likely to overpower the existing debt problems surrounding them. However, during the periods of economic crisis it is not simple for countries within Europe to abandon private self-centeredness for promoting unified economy. European leaders declared that they are focusing on an extensive proposal to attend to the economic crisis in the region. Several opinions are being suggested to address this point and a recapitalization of European banking system to make sure that they sustain more reserve financial support in the situation of a fiscal blow, higher haircuts to the worth of the debt observed in Greece that is contained by private sectors, and strengthening of European stability economy are being widely included in the plan.

A restructured worldwide economic crisis originating from the existing sovereign debt crisis in European nations can have a significant aftermath for developing economies and particularly for the lower income countries in this cluster. The fall down of the European Union fiscal structure can experience harsh and direct effects on the course of economic growth in underdeveloped economies in the world. More contagions in different parts of the globe would greatly intensify the progress of crisis in the poor economies and other developing countries.


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