The European Sovereign Debt Crisis

The European Sovereign Debt Crisis: The Return of the Greek Drachma?

There have been developments highlighting that there is some form of breakdown in the Eurozone, which is actually proving to be a considerably real risk. This has seen the European Union struggle with a crisis over the huge debts that its economies, especially the weakest, are facing. Among the recent ones is the current discussion that has revolved around Greece, which through its referendum had proposed for a bailout package and withdrawal of its membership from the Eurozone (Dor, 2011). Initially, this issue of the Greek exit had been an issue of the corridors and backrooms but has of late become outstandingly overt, with the voicing of various concerns from key people such as the Euro-group head, Junker, and the French President, Sarkozy. It is this particular development that has compelled a change in the Greek government policy. The case of Greece offers an opportunity to understand political issues of the Eurozone breakdown and to find out more predictable and less painful solutions than the Eurozone breakdown. In addition, Greece case study also highlights the major causes of the current European sovereign debt crisis.  Lastly, the Greece case is handy for suggesting some refinements in the EU to prevent a similar crisis in the future.

Political Issues of the Euro-zone Breakdown

The European sovereign debt crisis made a renewal of the interest in European integration and the Euro among central bankers, policy makers as well as researchers. In addition to this, the crisis brought about an exceptional challenge to the common European currency, the euro, thus, drawing attention to the issue of the success of the European monetary union, which is based on the homogeneity of this currency. This made the crisis not only an ordinary financial crisis but also a crisis of confidence with regard to the strength of the European Monetary Union (Franco, 2011).

Seemingly, the Greek debt crisis is likely to continue for long with the principal issue being the long period of time that the country will have to suffer. The country has also been subjected to austerity measures. These measures are being forced upon the country in exchange for a large amount of bailout money from the European Monetary Union (EMU), which is the European financial authority. In addition, Greece has been in the Eurozone and has had access to financing through the EMU. The pain is the aforementioned austerity measures on the country; under which there is the view that the state would be better if it were off the Eurozone exists. The stepping out option is likely to lead to a period of depression, thereby is politically indefensible. It ought to be noted that leaving the Eurozone is not so easy for Greece; it is likely to spark a run on banks, sovereign default, capital controls and bank defaults. This, notwithstanding the above mentioned, is more likely to take place for Greece irrespective of whether or not the country remains in the Eurozone (Belke, 2010). The probability that Greece will, after leaving out of the euro area, get to benefit from a nominal devaluation is quite measurable. This may sound somewhat upsetting, but there are a number of political issues that may strongly compel the country to take such a measure as will be discussed.

Firstly, leaving the Eurozone would preserve the democracy of the state. As part of the present debt crises, Greece lost its elected prime minister a year or so ago, following his opinion to subject the austerity to vote an act, which was against the wish of those who possessed the money. His position was later occupied by a technocrat. There was a call to the poorer Southern Europe countries by the technocracy that they should agree to take the draconian budgetary measures in exchange for funds in the event that there was further spread of the Greece crisis. In this manner, Europe could be better positioned in thwarting any attempts to save the euro and instead embark on preserving democracy - which is actually more material than a currency union; the EMU. In addition, Greece would recuperate its independence by returning to the drachma. This Greece pro-euro currency is in position to steer the country towards internal bootstrapping reforms (Roubini, 2012). There are some risky reforms that the drachmas made Greek avoid, following the ease of borrowing, which the euro had permitted. Moreover, the country could also be in a position to make reforms of its own welfare state, which would be a big advantage. The reforms would free the country from a history of political instability and political strife.

Major causes of the Eurozone Debt Crisis: Greece Case Study

The global financial crisis erupted in August 2007, soon after the collapsing of the United States’ sub-prime mortgage market. This had an enormous impact on the financial markets of Greece. This financial crisis gave birth to a global recession that strained the budgets of many governments, Greece being inclusive. To be more specific with the impact of this recession to Greece, its tax revenues weakened considerably, while the government’s spending hiked. In addition, this global financial crisis saw huge declines in both the shipping and tourism industries (both of which are principal to the country’s economy) (Dor, 2011).

The second cause of this crisis was the growing public debt and budget deficit. Between 2001 and 2009, the Greek economy was characterized by growing hard to defend fiscal and external imbalances. For the first seven or so year in this period, the country had been reporting annual budget deficits of 5% on average as compared to the 2% average annual budget deficits of the entire Eurozone. However, in 2009, the situation worsened; with the country’s budget deficit going past the thirteen per cent mark of the gross domestic product (GDP). In efforts to fund these twin deficits, Greece borrowed from international capital markets. Those borrowing never made the situation any better; borrowing actually left the country with a chronic high external debt of 116 per cent of the GDP in the same year (Franco, 2011). Both the budget deficit and the external debt for the country in this year lay far above the accepted levels as per the rules, governing the European Union’s EMU, ordinarily referred to as the Maastricht Treaty. In the subsequent six or so years, the Greece central government expenditures rose by 87 per cent, while its revenues recorded a staggering 31 per cent growth. This left the country budget at deficit above the European Union’s generally agreed upon threshold of three per cent. Since then, the country has had government budgets as well as current account deficits that the country can hardly finance using funds, borrowed from international capital markets. Tax evasion also equally led to the situation in Greece. This was as a result of tax collection strategies, which were considerably weak. As per the arguments of a number of economists, tax evasion in Greece as well as unrecorded economy played a pivotal role in causing the budgetary deficits. In further elaboration, it has been noted that the prevalence of tax evasion in Greece is rooted on the high taxation levels, the country’s complex tax code, presence of inefficiency in the public sector and excessive regulation (Belke, 2010).

Thirdly, Greece financial crisis was as a result of current account deficit. For a period of seven years up to 2008, the country had been reporting annual current account deficits, averaging at 9 per cent as contrasted to the Eurozone’s 1 per cent. Such huge budget and current account deficits are attributed to the high spending that the country’s successive governments have been involved with. In concrete figure and following the 2001 adoption of the euro by Greece, the country’s export to its principal trading parties grew averagely by 3.8 per cent annually. This percentage is actually half of the countries’ imports from other trading partner countries. As many of the Eurozone governments, the Greece government entered into the practice of misreporting the official economic statistics (Roubini, 2012). This misreporting being the fourth major cause was geared towards keeping the country financial position within the borders of the guidelines of the European monetary union. This misreporting likewise played a chiefly role in bringing about the crisis in Greece. At the start of the year 2010, it became public that the Greek government had made quantifiable payments to Goldman and other banks in terms of fee. These payments were dated back to 2001 and were in regard to arrangements that these banks had made on various transactions that in the actual sense hid the true borrowing levels of the government. These deals had been made by the various subsequent Greek governments so as to enable them carry on with their spending behind the knowledge of the actual deficit by the European Union (Zuleeg, 2011).

The above discussed causes led to the financial crisis in the EU and the latter brought about a number of consequences. For instance, there was the downgrading of the Greek bond. Additionally, the move by the Greek government to falsify statistics as well as the attempted obscuring of the debt levels via sophisticated financial instruments saw the dropping in the country’s investor confidence. This drop was evidenced by the high bond spreading. Moreover, there were threats that this financial crisis in Greece will spread to other Eurozone countries, an occurrence referred to as the contagion effect. In response to the Greece financial debt crisis as well as the contagion effect, the euro proportionately began to depreciate. Interest rates, on the other hand, were reported to shoot upwards (Roubini, 2012).

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With regard to this 2008 outbreak of the global financial crisis, there was a general recognition that there existed undeniable imbalances in the global economy. Many theories were born in efforts to expound on the cause of the imbalances as well as the extent, to which these resulted in the worldwide financial crisis. Notwithstanding this, it can be clearly drawn that these global imbalances in both the 2008 global financial crisis and the present European sovereign debt crisis were borne of the excessive leverage in both public and private sectors in the principal industrial economies. This, therefore, resulted into dangerous high level debts (Zuleeg, 2011).

Owing to the aforementioned high debt levels, members of the EU, and for this case Greece, opted to embark on a number of remedial tools. One of these was the fiscal austerity measures, where the country - in swap for a financial assistance - was compelled to submit a 3-year plan that was geared towards cutting down on its budget deficit by more than 10 per cent of the GDP between 2009 and 2014. Such measures would call for major cuts in the civil service in areas such as reducing or even freezing all civil pensions, bonuses and wages. On the side of the country’s revenue, the Greek government took steps to raise the average value-added tax by four percent and at the same time heighten the taxes on food, tobacco, luxury products and liquor. This is a hope of raising the GDP of the country by approximately 2%, thus, strengthening the country’s tax collection efforts as well as making a bigger contribution prerequisite for nationals who are fond of evading tax (Dor, 2011).

Structural reforms would be the next on line, since this will be encouraging Greek industries’ competitiveness via snowballing productivity, cutting wages significantly as well as increasing savings. In addition to this, Greece is under obligation to increase its exports through investing in the various areas, in which the country owes comparative advantage. The country could also receive financial assistance from the Eurozone and/or the International Monetary Fund. This financial assistance is geared towards lowering the country’s fiscal deficit by 5% by 2014. In substantiation of this statement, members of the Eurozone and the IMF in 2010 made a USD 145 billion endorsement financial package for Greece, which was made in an attempt to be off the hook of a Greek default as well as to stem Greece’s crisis contagion to other EU member countries, especially Portugal, Ireland, Italy and Spain, which are referred to as the PIGs economies (Franco, 2011). Following the United States’ USD 16.6 billion estimations in exposure, the default cost is likely to hike up since this will lead to a dramatic depreciation in the euro, thus, leading to many investors losing confidence in the euro. Thus, it will be somewhat inevitable to take measures such as quitting the euro, especially in the event that the potential risks are more likely to be more than the probable benefits and the legal implications. Alternatively, Greece could opt getting out of the Eurozone and at the same time devaluate its currency until that time that the country will have restructured its economy, which will see the country rejoining the Eurozone once more. It is quite easy to rescue Greece from the situation since its representation from the European Union GDP rests at 2.5% (Belke, 2010).

Although some economists argue that the only real way to restore growth and to reduce Greece’s debt is to have a massive depreciation with an exit from the Eurozone and a return to the drachma, the same is capable of having an extreme negative impact on the country’s economy as well as an extreme weakening effect on all the Eurozone countries. As a result, there is a need to pay attention to the above mentioned effects. For any country that may be willing to dissociate itself from the euro and do so in a legally acceptable and right manner and in line with the European treaty regulations, the same country ought to leave the European Union by following article 50 of the treaty. Later on then, the country can opt to rejoin the union but it is notable that it is obliged to ask for special dispensation as pertains to the EMU. Alternatively, the country, intending to leave the union, can negotiate an amendment to the treaty with other countries who are members of the EU. Both these alternatives call for lengthy negotiations and ratifications by the member countries, with an exception of none (Zuleeg, 2011).

Moreover, there are a number of difficulties that are closely linked with abandoning the euro by a single country or even a subset of countries. These difficulties in the EMU come about since the other countries are in possession of the euro. The EMU leaving country’s new currency, and in this case and with respect to Greece, the drachma will, under all circumstance, have to coexist with the euro that the other countries are keeping. Notably, therefore, it should not be assumed that any debt that Greece (being the country opting to leave the EMU) had in euros will be by default converted to its drachma. The situation would even be more critical in the event that the drachma will likely depreciate, thus, becoming worth lesser than its initial euro conversion rate. Greece’s economic situation has all through been deteriorating and new deals have involved bigger debts than those, previously consented by the country’s banks being written off (Roubini, 2012). The same problem is all evident in other Eurozone economies. In the past decade, many of other southern European economies have had huge debts; both mortgage loans and government debts. The problem these countries are facing is the repayment of these debts, especially when to take into consideration that their economies have been left quite uncompetitive with the high wage levels in the countries. It is even harder for these countries to call upon the European Central Bank (ECB) to lend them money since these countries are inside the euro. Moreover, they can hardly devalue their currencies in an effort to regain their respective competitive edges. As a result, the sole alternative  for these countries is to endure the spending cuts as well as the taxes rises, which is very painful for them (Roubini, 2012).

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Suggestion on Refinements in the EU to Prevent a Similar Crisis In The Future

With the abovementioned difficulties, the EU was necessitated to look for long-term refinements that will ensure that the same does not occur. Good enough, the union came to a common ground that, despite the present limitations, collective financial responsibility was the fundamental instrument in fighting the economic and fiscal crises. Altogether, the mere crafting of a mechanism of offering limited guarantees for debt support might not be at its least the inclusive remedy, needed by Europe (Dor, 2011). The PIGS economies are currently faced with the serious problem of the rupturing of housing, and thus, will have to undergo a long way in recession, while at the same time paying considerably high interest rates on their sovereign bonds. The effect of this will be the worsening of their debt situations. Thus, it is quite important for these economies to have reductions in their interest rates. On the same note also, the Eurozone can hardly restructure its unilateral and default debts since this will cause a state of panic and mistrust that will engender a ruin to the banks in all member countries. Therefore, it is evident that the solution to this lays in looking for a common ground between the creation of a financial and political mechanism acceptable for all of the European populace to cut down on their distressed countries’ debt via the replacement of the high interest bonds with cheaper ones as well as transfer to the European taxpayers the cost of this logical operation.

The breakdown of the Eurozone due to the sovereign financial crisis, happening among its constituent members, is risky. Many of the poorer members of the European Union, under which the EMU is formed, are struggling with intense debt crisis, which makes them tempted to leave the union. Political reasons like the desire to operate independently financially are driving forces for countries, Greece, for instance, to leave the monetary union. The nation would prefer to go back to using its own currency, the drachma instead of the euro, the currency of the EMU. The sovereign debt crisis had various causes, some being recession and huge public debt. The problems were intensified by undisclosed borrowing from banks by governments as they struggled to run their respective nations. To redress the budgetary deficits, leading to the financial crisis, individual nations have to act strongly to control their spending. Greece, for instance, has planned to impose major cuts on its budget for the civil service through reducing or even eliminating all civil wages, pensions, and bonuses. Opting out of the EMU would be costly for Greece as it would exacerbate and prolong its financial crisis. The European nations in the crisis should also incorporate collective financial responsibility, which can involve reduction of lending interest rates. 

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