"European Debt Crisis FAQ"
Why does Greece need a bailout?
This is pretty simple. The Greek budget is way out of whack and Greece can’t repay what it owes.
Why don’t the other Euro countries just let Greece default?
The concern is that if one Euro country defaults, this will increase the perceived riskiness of all European countries. The higher interest rates will be bad for everyone, but in particular could push countries like Ireland, Portugal, Spain, and Italy into default.
Well so what?
That many defaults would call other countries (Belgium, even France) into question. What’s more, the losses to banks would be enormous. Countries would then either need to choose between witnessing massive bank failures, or else engaging in bank bailouts much larger than the cost of just bailing Greece out.
Is this all caused by high taxes and socialism?
No. Sweden’s not on the Euro and they’re fine, notwithstanding high taxes. Even within the Eurozone, relatively high tax countries such as Finland and Austria are doing okay on their own terms.
How did the PIGS get into this mess in the first place?
Different reasons. Greece engaged in a lot of budget funny-business. Spain and Ireland had big property bubbles. I don’t know anything about Portugal.
More slowly — isn’t this all about irresponsible government spending?
In Greece, that’s a huge part of the story. In Spain and Ireland it’s really not. Much like the United States, both of those countries had massive private borrowing during the boom years, much of it to finance real estate development. Explanations for why exactly this happened in the USA vary, but it was all one big global phenomenon. Not only did this directly employ a lot of people, it had the secondary consequence of pushing wage levels up across the board. Then demand collapsed, leaving many Irish and Spanish indebted and unemployed while overall wage levels were fundamentally uncompetitive with Germany. The collapse in overall economic activity has created plunging revenues and budget crises.
Why can’t they solve this?
Many reasons, but first and foremost an extremely clunky decision-making mechanism. Big decisions in Europe need to be made by unanimous vote of all 27 EU members, even those that aren’t part of the euro. The constituent countries have different interests, are in different situations, and also have different governing coalitions. An idea needs to be acceptable to Spanish socialists and German conservatives and everyone in between. That’s simply hard to do.
What should be done?
At this point really anything. There are several different options that could “work.” The Eurozone could break up and banks could eat default losses. The Eurozone could break up and the stronger countries could bail out their banks. The Eurozone countries could embrace fiscal transfers. The European Central Bank could promise massive monetary stimulus in exchange for continent-wide austerity. The problem is that all workable options involve allocating losses to someone or other. Nobody wants the loss allocated to them, and since the decision-making process is so clunky it’s easy to block everything. Each time the can gets kicked down the road, it tends to expose the extent to which the decision-making process won’t lead to a big bang workable solution and everyone gets more nervous.
Can you end with a joke?
One possible idea would be for Greece, Spain, and Italy to all default on their debts followed by a German effort to conquer those countries in order to recoup losses. Then the United States would need to go to war to stave off German domination of Europe which, as we know from the 1940-45 experience, would stimulate the U.S. economy.