9713 Sami Ahmed Zia

Euro Zone Financial Crisis

Summary
The European sovereign debt crisis (often referred to as the Euro zone crisis) is an ongoing financial crisis that has made it difficult or impossible for some countries in the euro area to repay or refinance their government debt without the assistance of third parties. In 1992, members of the European Union signed the Maastricht Treaty, under which they pledged to limit their deficit spending and debt levels. Many of the member states fail to accompany with the requirement of Treaty due to the inconsistent accounting, off-balance-sheet transactions as well as the use of complex currency and credit derivatives structures. The major cause of the crisis resulted from a combination of complex factors, including the globalization of finance easy credit conditions, encouraged high-risk lending and borrowing practices, international trade imbalances, real-estate bubbles, fiscal policy choices related to government revenues and expenses. The major reason still being the violation of the EU Treaty that member countries should have control on the fiscal expenditure and reduce the deficit situation of the nation .The EU treaties contain so called convergence criteria, specified in the protocols of the Treaties of the European Union. Concerning government finance the states have agreed that the annual government budget deficit should not exceed 3% of the gross domestic product (GDP) and that the gross government debt to GDP should not exceed 60% of the GDP. For euro zone members there is the Stability and Growth Pact which contains the same requirements for budget deficit and debt limitation but with a much stricter regime. In the past, many European countries including Greece and Italy have substantially exceeded these criteria over a long period of time. To tackle the financial crisis it was assume that euro bonds will play a important role so that euro bonds issued jointly by the 17 euro nations using the term "stability bonds" by tight fiscal surveillance and economic policy coordination as an essential counterpart so as to avoid moral hazard and ensure sustainable public finances. In 2009 trade deficits for Italy, Spain, Greece, and Portugal were estimated to be $42.96 billion, $75.31bn and $35.97bn, and $25.6bn respectively, while Germany's trade surplus was $188.6bn A similar imbalance exists in the US, which runs a large trade deficit (net import position) and therefore is a net borrower of capital from abroad. Ben Bernanke warned of the risks of such imbalances in 2005, arguing that a "savings glut" in one country with a trade surplus can drive capital into other countries with trade deficits, artificially lowering interest rates and creating asset bubbles. As a result large trade surplus country increases the value of the currency and will increase the price of the exports.

Recommendations: Raising a country's level of saving is to reduce budget deficits and to change consumption and savings habits. Reduce to utilizing import goods Economies are more towards domestic services and increase wages to support domestic consumption. To reach sustainable level of the Euro zone must reduce its overall debt level by 6.1 trillion European Bank should impose Basel II recommendation with sufficient capital requirement Should have control on Credit Risk. Safe currency against to depreciate its value Reduce the fluctuation in changing the exchange rate. Correcting trade imbalances position Stop using derivatives and off balance sheet transactions.

Reference Links:
http://www.guardian.co.uk/business/debt-crisis http://en.wikipedia.org/wiki/European_sovereign-debt_crisis

The EU Crisis Pocket Guide by the Transnational Institute in English (2012) Italian (2012) Spanish (2011) 2011 Dahrendorf Symposium Changing the Debate on Europe Moving Beyond Conventional Wisdoms 2011 Dahrendorf Symposium Blog Eurostat Statistics Explained: Structure of government debt (October 2011 data) Interactive Map of the Debt Crisis Economist Magazine, 9 February 2011