European Debt Crisis

Topics: European Union, European Central Bank, Eurozone Pages: 7 (2818 words) Published: October 17, 2011
Current European Debt Crisis
Since 2010 fears of a sovereign debt crisis also known as the “Euro Crisis” has developed in Europe having direct impact on countries such as Greece, Portugal, Ireland and more recently European giants Spain, Italy, and France. What is on hand for these countries is a serious economic crisis that could involve widespread defaults and or significant rises in inflation caused by toxic short-term loans. The surreal thought of an entire country defaulting, is becoming more of a certainty surrounding Ireland and Greece specifically. The European Union and European Central Bank are at a struggle to maintain balance with powers France and Germany attempting to carry the burden of the struggling nations; have now seen an increase in their own accumulated national debt and short-term bank loans that must be repaid in the next 24 months. The current state surrounding this crisis isn’t unmanageable, though without swift action and new policy implementing along with a creation of a new monetary fiscal operation, Europe maybe stretched into abandoning governing members of their Union, and possible abandonment of their currency.

This current debt crisis surrounding Europe was due in part to European Central Bank’s installment of short-term loans and its false impression imposed on investors, those of which who were investors believed short-term loans to be more beneficial opposed to long-term papers. Originally, as noted within Peter Boone and Simon Johnson’s work entitled “Europe on the Brink” they note that, “Initially the Bank, treated all nations equally, regardless of their credit ratings, as a result, it became profitable for banks to buy short-term government papers and deposit that paper in the ECB in return for loans” (Boone and Johnson, pg. 2). After noting the desire for short-term paper, Boone and Johnson are quick to note three immediate risks surrounding these transactions. Firstly, the European Central Bank created government bonds that were highly liquid, in knowing that the buyer maintained the option to turn to the bank for immediate funds . What results from these highly liquid governmental bonds is a larger market for smaller European nations that would ultimately struggle issuing an inflated amount of national debt. Secondly, Boone and Johnson claim that the ECB and European Union, would never let a sovereign fail, due to the fact that each of the European banks generated a massive increase in short-term sovereign debt, where in return to this matter, sovereign investors themselves issued out more debt. Boone and Johnson however state that, “Sovereign defaults would be catastrophic for the banking system” (Boone and Johnson, pg. 2) and therefore the major governing organizations in Europe would never let this occur which leads into their last claim that high risk is involved surrounding banks who engaged in a high credit expansion. What is to come of this claim results in a system of severe uncertainty, due to the fact that investors were under the false impression. If a problem were to occur, it was thought governments and shareholders together would leverage reserve capital in order to prevent defaults.

Sovereigns believe they are under a blanket of protection from the bank, and believe they obtain the ability to take on high volumes of short-term debt. European nations currently reside under the impression that the Central Bank has the authority to print new cash flow for regular revenues making their investments more stable. If only however European banks operated under this measure accordingly. The problem surrounding this current debt crisis revolves around “Creditors that lent money to banks and the sovereign under an assumption that Europe would all be supported fully during times of need and trouble” (Boone and Johnson, pg. 3). Germany who is currently being asked to bailout many in need nations, is at the forefront of a new regime moving away from what was known as...
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