'Three serious 'external' crises: (1) The euro debt crisis'

Three different crises are simultaneously taking place and we are helplessly watching as bystanders. Yet, these developments have an impact on us. These dramas are the US economic recovery slowdown; the European debt crisis; and the Arab spring of revolutions across the Middle East. (In previous columns, I have discussed the US economic issues).

“How the crises affect us.” Each one of these developments helps to slow down world trade. Why? The strained economic position of the countries directly facing these crises means a reduction of their aggregate demand of their home output. A consequence of that is a fall in their demand for imports of goods. (For the Middle East, the impact is uncertainty in the volume of their energy exports.)

To the extent that our exports are affected, employment could suffer and. subsequently, profits, incomes, and slowdown of investments. Thus, these developments re-enforce the downward drift of output and demand.

Add to these the direct impact on Filipinos who live and are actively employed in these countries. Their respective livelihoods are directly put at risk so that their real incomes and their remittances homeward are reduced.

“The financial impact.” The movements of financial markets are more volatile than those of output and demand. Financials are influenced by immediate and short term developments, sometimes representing knee-jerk responses.

Financial uncertainties spark speculation in currencies, commodities, stocks and bonds. In our country, we see market responses in the stock exchange index (which has moved up and down between 2,100 to 2,400 percentage points in the last few weeks), in the price of bonds, in fuel prices for transport and cooking, and in the peso exchange rate.

“The Euro debt crisis: background.” All nations that make up the European Union (EU) have a combined GDP, which when adjusted to purchasing power, account for 20 percent of the world’s GDP. It is therefore the largest economy in the world.

Seventeen of these EU countries are banded into a single currency zone known as the Euro. Except for a few countries (including the United Kingdom and Denmark which are EU members) that opted out of Eurozone when it was adopted, all countries in the EU are obliged to become members of the monetary union provided that they meet a set of “convergence” targets (relative fiscal and monetary figures) invoking national discipline. In 2001, the euro was introduced and replaced national currencies of all the member countries. 

“The Greek debt problem.” When the US financial meltdown of 2008 happened, many European economies suffered economic downturn. Greece, which was heavily depended on tourism, was badly hit amidst the general economic slowdown. It also had a huge social welfare bill.

The Greek sovereign debt problem is the most severe of the country debt problems at this time. Ireland, Portugal, Spain, Italy, and several new Eurozone countries from Eastern Europe have had liquidity problems in coping with their debts. How the Greek debt “virus” unfolds will determine whether a financial epidemic results or is contained. Thus, the Greek problem has the making of a Europe-wide problem.

In Greece the problem is acute. The social programs that the government maintained could not be sustained in the face of sudden drops in aggregate demand and output and, therefore, in government tax receipts. Instead of retrenching to face the problems, the government engaged in creative accounting of its fiscal position to keep within the Eurozone guidelines. The Greek government was not unique in this practice. But its case came out widely in the open in early 2010 and revealed a fiscal position that was far worse than the government had made the world believe. The result was a rapid rise in refinancing rates for its debts.

The Greek sovereign debt is mainly financed externally by European banks. German and French banks have extended substantial loans to Greece. If the Greeks fail to service their debts as they fall due, a debt default results and these get into deep trouble.

The financial conflagration will fall on the European banking system. There is a tight network of interbank lending among the world’s banks. For this reason, all the European banks are affected, and then, the world’s banking system too.

“Financial danger to Europe… and the world.” After the first round of heavy financing of the Greek debt deficiency by the European central bank and the International Monetary Fund was undertaken, the next round comes up with more doubts arising that the Greeks are in an even more precarious situation. On the table now before Europe and by the international community concerns further financing to contain the Greek debt problem and monitoring compliance pertaining to the economic reforms in place.

For its part, the Greek government has put in place the spending cuts to deal with its problem. But the general public is reeking in discontent because of the painful economic reforms. Whether the political fabric could hold the social tensions from exploding is the big question facing the Greek nation.

A bigger question looms for Europe. Though Greece is a small country in terms of Europe, the exposure of the German and French banks to the Greek debt problem is quite sizeable. Moreover, there is a train of other European countries with debt problems arising from similar and other circumstances. If Greece defaults, will the Eurozone experiment hold and not implode?

The problem in Europe is similar to the problem that arose in the US when Lehman Brothers, the investment bank, collapsed in 2008. A larger contagion in the whole banking system in the US was averted. The government undertook a massive monetary and fiscal program that prevented a wider and deeper financial catastrophe. Something similar is needed in Europe. So far, however, that measure of political will which requires extensive coordination of economic policy at the European level is still missing.

My email is: [email protected]. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/