Why did the euro crisis blow up?
This crisis has been brewing since 21 July, when eurozone heads of state met in Brussels to agree the second Greek bailout and introduce new measures to stabilise markets. Confidence in the proposals lasted about 24 hours. The Greek package was seen as too little to allow the country’s economy to recover: Greece’s debt-to-GDP ratio could still hit 130%. A plan to prevent contagion spreading to Italy and Spain was seen as too tentative and complex, not least because the rescue vehicle – the European Financial Stability Facility (EFSF) – needs its new powers to buy sovereign bonds in the market ratified by euro area parliaments. Sceptical investors started to sell Italian and Spanish bonds, pushing yields on 10-year IOUs above 6%, when borrowing becomes prohibitive. The flames were fuelled by weak economic data: growth in Europe and the US seems to be slowing sharply, making the task of cutting debt mountains harder.
When could the EFSF be up and running?
José Manuel Barroso, the European Commission president, told member states to hurry up on Wednesday but it could take weeks, or even months, for approvals. His letter also called for a "rapid reassessment" of the EFSF, in effect admitting that its current €440bn of funds won’t be enough to come to the aid of Italy and Spain. German officials were unimpressed by Barroso’s move, grumbling that "it is not clear how reopening the debate just two weeks after the summit can lead to calming the market."
How big would the EFSF have to be?
At least €1tn, most economists say. Some think as much as €2.5tn to be certain that borrowing costs could be lowered permanently for Italy and Spain. This explains Germany’s lack of enthusiasm. As the biggest eurozone member, it would carry the greatest burden of underwriting the risks involved in a bond-buying spree. Expanding the EFSF could also spread the crisis further. Analysts are already asking whether France could shoulder its share while still retaining its own AAA credit rating. If France lost that rating its own cost of borrowing would shoot up.
What else could be done?
All eyes are on the European Central Bank. As an emergency measure, the ECB could support Italy and Spain by buying their bonds. On Thursday, however, the ECB merely bought some Irish and Portuguese bonds, disappointing investors who wanted a broader intervention. Jean-Claude Trichet, ECB president, appeared to signal that Madrid and Rome would have to announce deeper structural reforms to their economies before central-bank support would be offered. Trichet’s hardline stance was in character: he has consistently warned member states over rising debts. But frontline bankers argue that to stop the rot politicians should override Trichet and order the ECB to intervene on a massive scale.
Any other options?
There is one obvious remedy – eurobonds. Under this idea, members of the eurozone would issue bonds that would be underwritten by all states – in other words, all would accept ultimate responsibility for each other’s debts. However, this arrangementwould imply the creation of a new pan-eurozone treasury ministry with powers to dictate members’ budgets. That’s virtually the creation of a new super-state, say some. Electorates might not vote for it.
Is fiscal union even a realistic idea?
Not without the backing of Germany and France. However, the crisis is now moving at such a pace that monetary union may be doomed in its current form. Cash is flowing away from the periphery and towards Germany. Unless those flows can be reversed, growth and recovery become harder to achieve in the indebted and struggling nations. Germany could eventually face a simple calculation. What’s more expensive? Paying up to support its European neighbours; or suffering the economic fall-out from a break-up of the eurozone, its biggest export market.
What does it all mean for me?
The EU is our biggest export market for manufactured goods. But savers in most UK banks can sleep more easily than during the 2007-2008 crisis. Under the Financial Services Compensation Scheme, the protection limit for deposits is now £85,000 per person per firm. Just don’t expect savings rates to rise: the crisis is likely to mean interest rates will stay low for longer
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