When the credit crisis happened back in 2008, it seemed like an American problem. At the time, many Europeans smugly looked across the Atlantic to watch the problems the Americans had brought on themselves. That was before the credit crisis became their problem too.
Now, the problems seem to be spreading in the opposite direction. It appears that while American banks were lending to people who couldn’t afford a home, European governments were widening their budgets beyond what they could afford. Add an economic downturn with falling tax revenues, and several of these governments are in big trouble.
Things started off with Greece. Well-known for political unrest, it seems that Athens widened public programs to keep the people happy. In fact, Greece had to disguise the size of its debts in order to join the EU in the first place. As the size of the public debt mounted, speculators began pressuring Greek bonds. When several rating agencies downgraded the public debt, the problem reached epic proportions. Borrowing costs for Greece skyrocketed, and the government was on the verge of financial collapse. The other nations that use the euro recognized that a collapse would only spread to them, but the political will to do something about it was nonexistent. After more than a month of political posturing, the EU finally had no choice but to act, investing $1 trillion in keeping the nation afloat.
Michael Gelband’s Exodus Point launched in 2018 with $8.5 billion in assets. Expectations were high that the former Millennium Management executive would be able to take the skills he had learned at Izzy Englander’s hedge fund and replicate its performance, after a decade of running its fixed income business. The fund looks to be proving Read More
Unfortunately, this action was probably too late. Through the entire Greek crisis, economists predicted that a similar crisis could take place in Portugal, Spain and Ireland. Soon after the announcement of the European rescue, Fitch downgraded Spain’s debt—a replay of what happened to Greece. France’s minister of finance also intimated that their debt might be vulnerable to a downgrade. If other nations fall into the same problems Greece suffered, the costs on the EU will be astronomical.
All of these developments have raised shocking questions about the EU and even the long-term viability of the euro. During all of these developments, the euro has fallen to its lowest level in years. Even since the beginning of the European common currency, economists warned of inherent problems for the program. If the majority of the EU nations share a common currency, the actions of any member strongly affect the rest. At the same time, the EU does not provide for a high level of control over fiscal policy. In other words, a nation with poor fundamentals, like Greece, can spend freely with the confidence that a fiscally conservative nation like Germany will want to keep the euro strong. There is a built-in incentive to take advantage of the situation by following poor fiscal policies.
Of course, this was exactly the reason for the lack of political will when Greece needed a bail out. No one wanted to pay for another nation’s lack of self-control, but politicians recognized that they simply couldn’t afford not to. The common currency means that every member nation is vulnerable to a crisis that could spread quickly. In fact, it appears that it already is.
So what is the long-term solution? The EU will have to solve their present problems with one of two answers: they must move either closer together or further apart. On the one hand, they could establish more fiscal control over member nations. In other words, Germany and France would have the right, along with the other EU nations, to force Greece and Spain to be more conservative with strong austerity measures.
The other solution would be to abandon the euro altogether. Naturally, this would cause the nations to drift further apart, and Greece or Spain could suffer the results of their actions without jeopardizing everyone else.
Either way, the EU has a bumpy road ahead. As it affects forex, expect to see the euro follow a long path downward as investors calculate risk into the value. You can also expect to see some interesting political developments, as the nations try to determine and effect the best response. Finally, there will certainly be implications across the Atlantic. In the worst case scenario, a string of European crises with sovereign debt would end in a drastic national crisis in the US. In such a scenario, Greece would be only a canary in a coal mine, and the world would be in for a long, difficult economic adjustment. Whatever happens, the future will hold some interesting times for Europe, and possibly the world.