The Eurozone Crisis: Causes and Potential Solutions

Causes and Solutions to the Eurozone Debt Crisis

Euro damaged
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The Eurozone Crisis began when investors became concerned about growing levels of sovereign debt. As they began to assign a higher risk premium to the region, sovereign bond yields increased and put a strain on national budgets. Regulators noticed these trends and quickly setup a 750 billion euro rescue package, but the crisis continues to persist due in large part to political disagreements and the lack of a cohesive plan among member states to address the problem in a more sustainable way.

In this article, we'll take a look at some of the underlying causes of the Eurozone Crisis and potential solutions to remedy the problem over the coming years.

Eurozone Crisis Timeline & Causes

Many experts agree that the eurozone crisis began in late 2009, when Greece admitted that its debt had reached 300 billion euros, which represented approximately 113% of its gross domestic product (GDP). The realization came despite European Union (EU) warnings to several countries about their excessive debt levels that were supposed to be capped at 60% of GDP. If the economy slowed, these countries could have a tough time paying back their debts with interest.

In early 2010, the EU noted several irregularities in Greece's accounting systems, which led to upward revisions of its budget deficits. Ratings agencies promptly downgraded the country's debt, which led to similar concerns being voiced about other troubled countries in the eurozone, including Portugal, Ireland, Italy and Spain, which had similarly high levels of sovereign debt.

If these countries had similar accounting issues, the problem could spread to the rest of the region.

The negative sentiment led investors to demand higher yields on sovereign bonds, which of course exacerbated the problem by making borrowing costs even higher. Higher yields also led to lower bond prices, which meant larger countries and many eurozone banks holding these sovereign bonds began to lose money.

Regulatory requirements for these banks required them to write down these assets and then bolster their reserve ratios by saving more than lending - putting a strain on liquidity.

After a modest bailout by the International Monetary Fund, eurozone leaders agreed upon a 750 billion euro rescue package and established the European Financial Stability Facility (EFSF) in May of 2010. Eventually, this fund was increased to about 1 trillion euros in February of 2012, while several other measures were also implemented to stem the crisis. These measures were highly criticized and unpopular among larger successful economies, like Germany.

Countries receiving bailout funds from this facility were required to undergo harsh austerity measures designed to bring their budget deficits and government debt levels under control. Ultimately, this led to popular protests throughout 2010, 2011 and 2012 that culminated in the election of anti-bailout socialist leaders in France and likely Greece.

Potential Eurozone Crisis Solutions

The failure to resolve the Eurozone Crisis has been largely attributed to a lack of political consensus on the measures that need to be taken.

Rich countries like Germany have insisted on austerity measures designed to bring down debt levels, while the poorer countries facing the problems complain that austerity is only hindering economic growth prospects further. This eliminates any possibility of them "growing out" of the problem through economic improvement.

The so-called Eurobond was proposed as a radical solution - a security that was jointly underwritten by all eurozone member states. These bonds would presumably trade with a low yield and enable countries to more efficiency finance their way out of trouble and eliminate the need for additional expensive bailouts. However, these concerns were mitigated over time as deflation took hold and bonds became a safe-haven asset for investors seeking yield.

Some experts also believed that access to low interest debt financing will eliminate the need for countries to undergo austerity and only push back an inevitable day of reckoning. Meanwhile, countries like Germany could face the brunt of the financial burden in the event of any Eurobond defaults or problems. The primary problem in recent years, however, is prolonged deflation that could keep growth at bay.

Key Takeaway Points

  • The Eurozone Crisis arose from high levels of sovereign debt being held by countries that were simultaneously facing high budget deficits.
  • Concerns over high bond yields have abated in recent years as deflation has gripped the global economy and forced investors to bring down bond yields.
  • The ultimate solution to the Eurozone Crisis remains elusive as the region continues to struggle to find a way to sustainable economic growth.

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