saif kothari

8/3/2019 saif kothari

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In 1958, an

organization called

European Coal and

Steel Community was

formed. This evolved

into the EuropeanUnion (EU) which

was established by

the Maastricht Treaty

in 1993. The

European Union

introduced the euroon January 1, 1999.

On this day, 11

member countries of

the EU started using

euro as their

currency. It benefitedcountries such as

Portugal, Italy,

Ireland, Greece and

Spain (together now

known as the PIIGS)


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Before these countries started to use the euro

as a currency, they had to borrow money at

interest rates much higher than the rates at

which a country like Germany borrowed. When

these countries started to use the euro they

could borrow money at interest rates close tothat of Germany, which was economically the

best managed country in the EU

The rest of

Europe, in

effect, usedGermany's

credit rating

to indulge its

material

desires. They

borrowed ascheaply as

Germans

could to buy

stuff they

couldn't

afford


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Also other than the low interest rates, the

inflation in the PIIGS countries was higher

than the rate of interest.

It means that, if the

borrowing rate is 3 per

cent while inflation is 4

per cent you're

effectively borrowing

for 1 per cent less thaninflation. You're being

paid to borrow

And borrow they did. And the European peripheral countries (PIIGS) racked up enormous

amount of debt in euros.' The debt ofGreece, currently amounts to around 160 per cent ofits

GDP. So, other than the citizens, the governments also started to borrow. This helped

politicians keep their constituency of voters happy


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Take the case of Greece. A job which now pays 55,000 euros in Germany, pays

70,000 euros in Greece, even with the fact that Germany is a more productivenation. To get around pay restraints in the calendar year the Greekgovernment simply paid employees a 13th and even 14th monthly salary --months that didn't exist.

There is more to come. The Greek government categorises certain jobs as

arduous. These jobs have a retirement age of 55 for men and 50 for women.'As this is also the moment when the state begins to shovel out generouspensions, more than 600 Greek professions somehow managed to getthemselves classified as arduous: hairdressers, radio announcers,musicians

It means more and more borrowing by the government, when they alreadyhave so much debt


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Take the case of Spain. Spain had thebiggest housing bubble in the world."To put things in perspective, Spainnow has as many unsold homes as the

United States, even though the US is sixtimes bigger. Most of these new homeswere financed with capital from abroad.Spain's real estate debt comes toaround 50 per cent of its GDP

Every time there are default threats, the

European Central Bank (ECB), helps outwith a bailout.

Since the start of the financial crisis it(the ECB) has bought, outright,something like $80 billion of Greek and

Irish and Portuguese governmentbonds, and lent another $450 billion orso to various European governmentsand European banks, accepting virtuallyany collateral, including Greekgovernment bonds


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'The German governmentgives money to therescue fund so that it cangive money to the Irish

government so that theIrish government cangive money to Irishbanks so the Irish bankscan repay their loans tothe German banks,

But wouldn't it be easier for the German government to just pay the Germseparately, instead of taking this long and convoluted route?

The situation is pretty messy because itis interlinked. Take the case ofGermany, which keeps contributing theECB rescue fund.

In case of Greece, a lot of GerFrench banks which have lentwill be in trouble if Greece def


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In 2004, interest rates in Hungary were at 12.5

per cent. This meant borrowing money wasextremely expensive, In neighbouring Austria,the banks had started to offer loans andmortgages to their customers in Swiss francs.Rates in Austria, at 2 per cent, may have beenlower than in Hungary, but in Switzerland, theywere even lower at around 0.5 per cent. Whywould Austrians borrow at 2 per cent when theycould just as easily borrow at 0.5% per cent? .The same question applied to Hungarians,except that the difference was much bigger. Sothe Austrian banks, many of which also hadbranches in Hungary began to engage in the

same business there, lending to Hungarianborrowers.


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Austrian banks have lent 140% of their GDP to countries like Hungary. Even though Hungary hasput in austerity measures and is trying to repay, if there was a blow up, the Austrian governmentwouldn't be able to save the banks and ECB might have to step in

Swedish banks have also lent a lot of money to Estonia, Lithuania and Latvia, countries whichaspire to have Euro as their currency some day

When countries go back to their own currencies to print it and repay debt, citizens will beaffected.


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When a country printscurrency in hugequantities, thecurrency will not

remain of any realvalue. So the citizensof the country will tryand move their moneyto either other assetslike gold, or will

continue using theeuro. This will lead tobank runs, with all thepeople queuing up atbanks at the sametime demanding theirmoney back. This, ofcourse, will lead to alot of banks collapsing


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Mauldin and Tepperelaborate on this using theexample of Italy.

'Households and firms,anticipating that domesticdeposits would beredenominated into the lira(Italy's currency before itstarted using the euro),

which would then losevalue against the euro,would shift their depositsto other euro-area banks. Asystem-wide bank runwould follow. Investorsanticipating that theirclaims on the Italiangovernment would beredenominated into lirawould shift into claims onother euro-areagovernments, leading to a

bond market crisis. . . thiswould be the mother of allfinancial crises,' write theauthors,"


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Reference Book:ENDGAMEByJOHN MAULDINAndJONATHAN TEPPER

eBook Publisher:

John Wiley & Sons

Imprint: Wiley

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