European Union: Has The Eurozone Been Saved?

Last Updated: 23 December 2011
Article by Paul Wood

This article was written on 27 October 2011 and therefore given the unprecedented speed of change, the eurozone will likely be a very different place by the time you read this.

On 26 October 2011 the leaders of the European countries in the eurozone declared a three-pronged strategy to prevent financial meltdown. So will a 50% write down of private bank debt in Greece, European banks being forced to recapitalise to the tune of €106bn and an expansion of the bailout fund to €1tn really prevent a eurozone collapse? Well the short answer, I believe, is possibly for a few weeks, but long term it is likely to fail and for reasons that many of the leaders already know.


Following the agreement, a staggering statistic reported was that even with the write down proposed, Greece's debt will still be at the same level in ten years time as it is now. That is after implementing disastrous austerity measures which will result in a contraction in the Greek economy which hasn't been factored into the economist's calculations. It is almost certain that the current Government, which has decided to cut the deficit purely by means of austerity programs, will be ousted at the next election in 2013. This is likely to then undo the agreement that has just been reached.

The Greek people no longer want to be in the euro; they have nothing to lose by causing civil unrest as they believe that unless they leave the currency they have no economic future. Unless the Greek economy grows it cannot ever pay back the debt it owes and its credit rating is considered 'junk' by the rating agencies, meaning it is still highly likely to default. It beggars belief that the current write down in debt is not considered a credit event on European banks.

Greece is expected by most economists to leave the euro at some point in the future as, if the Greek Government do not make this decision, its people will force it to do so. By that time the eurozone will have sunk several €100bn into Greece which will be lost.

Borrowing cost

The cost of borrowing for the governments in Portugal, Italy, Ireland, Greece and Spain (PIIGS) has now reached dangerous levels. Just two days after the agreement on Europe, Italy's cost of borrowing reached record levels, at 6.06% for ten-year bonds. This continues to rise showing that the bond markets do not believe that the agreement reached makes buying Italian debt less risky. An interest payment for any country over 6% is considered unsustainable and for a country like Italy, which needs to raise about €300bn on the bond markets in 2012, it will be disastrous.

Italy is not growing and is likely to enter recession shortly, yet it has committed to a further €60bn of austerity measures which few believe they can deliver. Without growth Italy will require a bailout and there is not enough money in the European Financial Stability Fund (EFSF) to do that, even when boosted to €1tn. Telegraph columnist, Liam Halligan writes: "A default by Italy, the eurozone's third biggest economy and the eighth largest on earth, would make Lehman look like a picnic."

Agreement illegal?

In addition, within days of the agreement Germany's constitutional court suspended the rights of a small parliamentary committee to approve urgent actions required by the EFSF. The full German parliament must now approve any EFSF bond-buying. This is unlikely as any bond-buying must be done in secret and the German parliament cannot meet in such a way. So for the time being the European Central Bank will have to continue buying the bonds of the debtridden PIIGS countries.

Commitment to austerity

The PIIGS will be reluctant to implement austerity measures as they get closer and closer to elections for fear of the electorate venting their anger at the polls. What happens if the current Governments are ousted? Will they renegotiate or just pull out of Europe because the burden of staying in is too great? With many believing that the eurozone will enter recession as austerity measures are implemented, it is highly likely that more austerity measures will need to be introduced just to balance budgets as tax collections will inevitably be lower. This downward spiral will eradicate growth and cause significant pain to all who trade with the eurozone.

A flawed concept?

The concept of the euro was a good one, but was fundamentally flawed by trying to fix one interest rate across the euro for such diverse economies. By admitting countries who were not ready, and by not managing their budget deficits tightly, the euro has destroyed itself. It will be consumed from within, either slowly, by continuing to prop it up with funds that don't exist, or quickly, by allowing countries to exit and default. Whatever happens, the eurozone, as an economic block, will look very different in ten years' time and the fallout will affect all countries in Europe as contagion spreads.

As an insolvency practitioner, I know that you cannot keep putting money into a business if the underlying business is not feasible; eventually the business will become insolvent. In addition, the longer you keep putting money in the more spectacular the failure is. Europe is in a similar position but on a much larger scale with far more at stake. Unless a decision is taken soon to restructure the eurozone, which will involve countries being forced to leave, the failure is likely to be spectacularly bad for everyone in Europe. However, an early restructure with the associated pain will be far better in the long term.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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