The Eurozone Debt Crisis Explained and Why It’s Not Over Yet

In 2009, the global economy appeared to be recovering quite nicely from the ’08 Sub-Prime Mortgage Crisis.  By March of 2009, the recession seemed to bottom out—equity markets began to rally, unemployment began to fall, and economic growth resumed.  It appeared that the global economy had weathered the worst of the Crisis.  Investor sentiment was broadly optimistic throughout the world, and the EuroZone was leading the recovery.  The European Central Bank had injected far less economic stimulus into its economies than the United States had, and the Euro suddenly seemed poised to make a serious run at the U.S. Dollar’s world reserve currency status.

But then another surprise hit financial markets.  In November of 2009, it became evident that Greece and several other EuroZone countries were in serious danger of defaulting on large amounts of sovereign debt.  The run on the Euro was merciless as investors began to question the very existence of the Euro.  There was talk of the Euro going to parity with the U.S. Dollar after it had reached the $1.5000 level in November, and there were even talks that the EuroZone may break up.

Finally, in late May of 2010, after months of speculation and political debate, the European Central Bank stepped in a created a bailout fund for struggling EuroZone countries.  It was now certain that no EuroZone countries would default, at least in the near-term.  This move by the ECB served to reassure investors, and the Euro finally found support at $1.1875 before beginning a magnificent rally in June and July back up to the $1.3300 area.  During the rally in June and July it appeared the EuroZone had survived the worst of the Debt Crisis.

During June and July, Greece, Spain, and Portugal each returned to capital markets and all three countries had very successful bond auctions.  In fact, they were each able to auction off full amounts at interest rates that were quite attractive.  This served to further support investor sentiment.  However, the true underlying crisis in the EuroZone is far from over.

First let’s examine how these countries came to near sovereign default.  When the EuroZone initially formed, one of the major incentives for small, economically weak countries such as Greece to join, was that they would be able to borrow money at near German interest rates.  This was very attractive because at the time Greece was being forced to pay a much higher interest rate in capital markets.

Now, as a EuroZone member Greece would be able to borrow lots of money at low interest rates, and this is exactly what they did.  The idea behind cheap money for weak countries was that these weak countries would be able to borrow money and develop strong economic and public infrastructure, which would make Europe much stronger overall, and as a whole they would be able to challenge the United States as a world power.  But things went bad…awfully bad.

Greece did borrow money, as did Spain and Portugal.  But they didn’t use it as they should have.  Infrastructure was never developed the way it should have been, and now these countries are sitting on mountains of debt they can’t pay off.  Thus, one of the requirements to qualify for bailout funds was these countries had to cut back on public spending significantly, which is causing quite an uproar among citizens.  These aggressive budget cuts have alarmed many economists, as they fear these austerity measures may weigh heavily on EuroZone growth in the 2nd half of 2010, and in a worst case scenario even tip the EuroZone back into a quarter of GDP contraction.  Forex software used by FX traders has helped many financial speculators profit from the rise and fall of the Euro in the last year.…

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