Crisis in Europe (III)
Let’s see how the situation developed in time. And we will start in 1999 when the Eurozone was created. Basically in order to increase competition and the level of integration in the countries that formed at that time European Union it was decided that it is necessary for each country to adopt a common currency, known as Euro. Many warned about the necessity that integration should go deeper then that, up to decreasing the role of governments of individual countries in fiscal and budget decision by giving the power of decision to different institutions coordinated directly by the European Union. That was not the case, at that time, because politicians form each country speculated the strong nationalist feelings of population in order to not lose control. So, in order to diminish the risks, some control rules were imposed, stating that no country could run under annual deficits more then 3% of GDP and total public debt can’t overcome 60% of GDP. In theory, the European Union could open a procedure in order to sanction the countries that weren’t able to respect these conditions.
Ironically, first nails in this pretty fancy coffin were the opera of the most important countries from Eurozone, France and Germany. These countries broke the pact in 2003 and escaped being sanction with promises that in the future they will respect the pact. That led to the suspension of the Stability and Growth Pact that contained these basic rules, until 2005 when it was reinstated in a much more flexible form that allowed the members of Eurozone to overcome the rules without fear of sanctions. Since then, every country from Eurozone except Estonia and Finland has broken those rules repeatedly, especially beginning with 2008 when the global crisis lead to higher deficits, both because sinking revenues from taxes and increased expenses in order to sustain growth and key financial and industrial companies.
So, up to 2010 Eurozone “evolved” in a wrong way with the government debt. Basically, government debt rose from around 72% in 1999 to 85% in 2010. However, up to 2007 government debt was actually lower at Eurozone level, around 67% at the end of the year 2007. Basically, during 2007-2010, the total government debt advanced with a median of 6% from GDP. Why that happened? All of the sudden all governments from Eurozone became irresponsible and started to throw money all around? Well, actually, the problem derived form another source, respectively the private debt. From 1999 to 2007 was a cycle of economical growth, based unfortunately mostly on credit. What happened was that everyone and his dog started to buy things (houses, cars, computers and so on) not because they afford it but because some banks were good enough to lend them the money to do so. Corporation borrowed also money for increasing their production facilities. Eurozone reduced naturally the public debt reported to GDP mainly because GDP increased faster than public debt. During this time though, household debt rose from 52% to 70% and financial institution increased their debt from below 200% to 250%.
Well, so far so good. But why after 2007 public growth increased? It is simple. Since summer of 2007 became clear that this kind of growth was not sustainable anymore. People were so much indebt that couldn’t keep up with the supply from the economy. Production facilities began to close. Prices of houses felt rapidly. More and more people lost their jobs and couldn’t pay their credits anymore. Also, the derivatives that most banks were happy to adopt as tools for great profits backfired in their faces. The hideous spectrum of bankruptcy of many important (some called systemic banks) grinned on the horizon. Then, officials form Eurozone assessed the situation and decided that financial system must be protected with all costs, because of their important role in the economy. So, some banks were nationalized, other along with large corporations received money from the states to keep their operation running. That was of course made with the expense of increasing public debt. Since then, ironically, financial system decreased their vulnerabilities derived form private institution and household only to see the danger again, coming this time from the distinct possibility that some states can not repay their debts that increased beyond sustainability only to help the financial institution survive. That is what I call irony.
So, the point is that both public and private debts must be taking in consideration by anyone trying to analyse the current situation, because those two aspects, based on the inextricable links that are formed between them, are just two faces of the same problem.