Wednesday, September 28, 2011

The Euro crisis: an overview of the current situation

The Euro crisis has now reached a dramatic turn and the survival of the currency is at stake. The debate is whether to remove Greece out of the Euro zone or to unwind the single currency. In the second case, the ramifications for the world economy will be huge and unless the euro-zone governments unite and devise a set of financial measures aiming to curb the crisis and improve the management of the Euro currency, the latter faces risk of disappearing.

It is crucial that stronger countries such as France and Germany help to shore up weaker links such as Portugal, Italy, Greece, and Spain, the four countries being commonly known as PIGS, and ensure that their debts are restructured. The macroeconomic policy of the Euro zone needs to be addressed to promote growth and prevent another crisis going forward. Cooperation between the European nations and the European Central Bank (ECB) is called upon to prevent further waves of panic on the financial markets brought about by the levels of debts of some of the governments combined with the low growth levels being displayed by the European countries and the frailty of the European banks’ finances.

While being solvent, Spain and Italy are short of liquidity. As such, a default of the Greek government on its debt does not make sense with the country still running a primary deficit. Savage cuts will still be needed following the default. The idea that Greece is let loose from the Euro is gaining traction amongst Eurocrats, but the move forward remains blocked by the fact that there is no current way to prevent collateral damages. What is needed right now will be measures to prevent the PIGS to be attacked once Greece goes into default, re-capitalisation of European banks, and we would argue to a point where it should cover theoretical losses from another PIGS, and controls to prevent domestic run on banks. We see it very difficult for the Greeks to pursue the unilateral step of default before a primary surplus is achieved, thus preventing a “sudden stop”. Policies aiming at the privatization of some of the government institutions along with a reduction in bureaucracy and an extension in the age of retirement would be a step to creating the necessary environment for growth. A higher commitment from the ECB, where it states that it will put forward any required resources to assist the countries facing difficulty, is also warranted in order to restore confidence in the markets.

In line with the above, allowing Greece to remain within the Euro zone, after serious restructuring, is the preferred option. The Germans may not be in favour of standing behind the weaker countries, however the alternative would be to allow the Euro zone to die. If Germany opts out of the Euro and is followed by a few other relatively healthy countries, the results would be tragic leading to high currency volatility and panic on the financial markets and eventually to a collapse of the single currency.

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