The Eurozone on the Verge of its Dismembering. My Attempt at Explaining the Drama in Europe in Simple Words – Part 1

Setting the Frame

The Global Financial Crisis that started in 2008 and shook the world is now considered one of the longest since the Great Depression of the 1930’s. While the US are experiencing a mild growth which is making them see the light at the end of the tunnel, and while the emerging markets are pulling themselves out of the mess, the 3rd major player in the global economy, namely Europe, is still trapped in quicksand dragging the other two and the entire world with them into worrying about the strength of their parachutes. More simply, investors all around the world have their eyes on Europe, and precisely nowadays Athens, since an earthquake there could potentially engender a devastating Tsunami from the coasts of California to Beijing.

 

While some low key media and people try to picture the origins of the crisis as being tied to the Greek laziness and inability to control their spending, or the German selfishness and authoritarian behavior, the real reasons for the crisis are not that simple. It is therefore an ambitious attempt that I make here, which is to lay down in simple terms the main issues that have been dragging the resolution of this crisis for almost two years now. Before I do that, and given that my audience ranges from people who do not have basic knowledge in macro-economics to PhD students in Economics, I have to make a few disclaimers to make:

  • While the following is a simplification of the reasons for the crisis, none of those reasons are in reality as simple as they sound when I attempt to explain them.
  • The following is not an exhaustive list of one size fit all explanation for the distress in Europe. Economics in the end is a social science whereby people from different backgrounds might interpret the same data in different ways, and there might be others factors which I have omitted or am not aware of that have contributed to the mess.

This note, given its length, will be broken down into 4 parts, each one of them treating one aspect of the crisis. The 4 parts are the following:

Part 1: Debt and the Crisis: Causality or Correlation?

Part 2: The Mercedes and the Feta Cheese

Part 3: The Disappearance of Currency Risk & the Animal Spirits

Part 4: Monetary Union and Fiscal Autonomy

Part 1: Debt and the Crisis: Causality or Correlation?

First and foremost, it is important to investigate a popular idea that sovereign debt is the reason for the Euro Crisis. Greece, Spain, Italy and the remaining “Club Med” countries or more seriously the periphery of the Eurozone just went on and borrowed beyond their means for some reason and are now finding it difficult to return the money. While the following map of Debt to GDP ratios taken from the Economist clearly shows Europe as a very indebted area, it is not far from the levels of the US, and certainly below the close to 200% Debt to GDP ratio of Japan.

Also, within the Euro area, with the exception of Greece, the debt levels are high across the board. Germany’s debt to GDP ratio was close to 75% in 2011, between Spain’s 61% and France’s 82%.

Now what about the debt levels of the GIPSI at which all the fingers point. Here it is worthwhile to take a look at Paul Krugman’s favorite chart, which is the evolution of the Debt to GDP ratio in the periphery of the Eurozone (PIGS, PIIGS or more respectfully GIPSI countries, standing for Greece, Italy, Portugal, Spain and the sometimes omitted Ireland). We can clearly see here that Debt to GDP ratios rose dramatically after the start of the Global Financial Crisis, and as a response to it. It is therefore not long-dated irresponsible spending by these the GIPSI countries that has brought their demise. It looks like unsustainable sovereign public debt levels are more a consequence of the crisis than a cause of it.

To be continued

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5 Responses to The Eurozone on the Verge of its Dismembering. My Attempt at Explaining the Drama in Europe in Simple Words – Part 1

  1. Nicolas Kseib says:

    lol I don’t think PhDs in economics understand the difference between causality and correlation 😛

  2. indeduction says:

    bro I know you’re joking but if Taleb of whom I know you’re a big fan denigrates economists like he denigrates everybody else except himself it doesn’t mean that he is any smarter than any of them

  3. Ed Grigorian says:

    In my opinion Greeks failed because their economy was/is linked to the sun. They were corrupted by centuries of Turkification and easy access to credit made them complacent and regressive.

  4. 1ina1e9 says:

    Cheap credit at fault again… One would think that the EU leaders would learn from the mistakes of the Americans (and themselves) but now they once again want to “grow” themselves out of debt. Unfortunately it seems like the Keynesian mindset is just drilled in too deeply for them to see the truth.

    On the EU though, I don’t quite know how anyone thought that you could bind countries like Germany together with countries like Greece under a single currency and end up with a working system. Naturally, Greece will simply not be able to compete with Germany if they play under exactly the same rules.

  5. Che says:

    There were/ there are/ there will be countries depending on the Sun for the Economy. Fortunately, they will not face such crisis as Greece do.
    Now back a little bit on history : military spend for Greece was the highest (in term of GDP) the past 25 years, btw 4% and 5%..
    The big ennemy was…… Turkey, and the Germany,France and USA were selling ships and jets for billions to Greece.
    Now they are putting reasponsability on Greek people.. as lazy and enjoying sun and feta..
    The world is fun

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