The Eurozone in Crisis

Dans un long article pour le Council on Foreign Relations de New York, Christopher Alessi revient sur l’histoire de l’euro et souligne que l’intégration monétaire et financière de plus en plus poussée entre en contradiction avec l’absence d’une politique économique commune.

The euro was introduced in 2002 as the single currency of the European Union, consolidating the largest trading area in the world and soon rivaling the dollar for global supremacy. However, the accumulation of massive and unsustainable deficits and public debt levels in a number of peripheral economies threatened the eurozone’s viability by the end of its first decade, triggering a eurozone sovereign debt crisis. The crisis highlighted the economic interdependence of the EU, while also underscoring the lack of political integration needed to provide a coordinated fiscal and monetary response.

The eurozone’s wealthiest members, led by Germany, have called on weaker states to embrace strict austerity measures in exchange for financial support, inciting popular unrest and toppling governments throughout the eurozone periphery. At the same time, the European Central Bank, under the leadership of Mario Draghi, has stepped in forcefully to prop up the euro and calm volatile markets. The crisis has also highlighted instability in the financial sector, most recently in Cyprus, underscoring the dangerous feedback loop between governments and banks.

A Post-War Community

Following World War II, France’s Jean Monnet, considered the founding father of modern Europe, argued that economic integration would be vital to eliminating intercontinental conflict in the post-war period. He was the chief architect of the 1951 treaty that established the European Coal and Steel Community, at the time the most significant step ever taken toward European integration. The treaty put the management of iron ore along the Franco-German border under collective control, preventing both countries from single-handedly controlling the ingredients needed for manufacturing arms.

The single currency was built on Monnet’s belief that economic integration was integral to European peace and prosperity. "The way to build the new union was through incremental steps toward economic integration that one day would lead to political integration," Franco Pavoncello, the president of Rome-based John Cabot University, wrote in May 2011.

Building the Common Market

The next major step toward European integration occurred in 1957 when France, Germany, Italy, Belgium, the Netherlands, and Luxembourg signed the Treaty of Rome, establishing the Common Market and the European Economic Community (EEC). The Common Market, which abolished trade tariffs between members, helped the EEC to embark on a rapid growth path. Shortly thereafter, the six countries agreed to joint control over food production, a decision that spurred further integration, and, Pavoncello notes, "helped seed the collapse of communism and the birth of globalization."

European integration and expansion accelerated in the decades that followed, especially with the signing of the Single European Act in 1986 by the twelve EEC nations—Belgium, Denmark, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and the UK. The primary aim of the treaty—which took effect in 1992—was to facilitate the development of an internal European market, allowing for the free exchange of capital, goods, and people. The move quickly highlighted the need for monetary coordination.

Maastricht and Monetary Union

In 1992, the Maastricht Treaty, or the Treaty on the European Union, formally created what is today known as the EU, and led to the circulation of the euro currency in January 2002.

By 2013, there were twenty-seven member states of the EU, with Croatia set to become the twenty-eighth by July of that year. Seventeen EU member states—Belgium, Ireland, France, Luxembourg, Austria, Slovakia, Germany, Greece, Italy, Malta, Portugal, Finland, Estonia, Spain, Cyprus, Slovenia, and the Netherlands—are part of the eurozone. Several EU states, including Bulgaria, the Czech Republic, Latvia, Lithuania, Hungary, Poland, and Romania, are potential eurozone candidates.

Maastricht laid out criteria for European countries that wanted to enter the so-called eurozone. All states had to have their financial houses in order by ensuring inflation was no more than 1.5 percent a year ; keeping budget deficits at no more than 3 percent of GDP ; and maintaining a debt-to-GDP ratio of less than 60 percent.

To meet these criteria, many countries had to adopt strict budgets by cutting public spending and raising taxes. In reality, the enforcement of these standards was not consistent. "There was shockingly weak due diligence in assessing the suitability for entry into the euro, and equally weak application of the few rules that were supposed to police its operation," explains hedge fund manager Jason Manolopoulos in his 2011 book Greece’s Odious Debt.

Global Meltdown and Sovereign Debt

Analysts note that the powerful original members of the EEC, such as Germany, were eager to develop a large and competitive eurozone, and so allowed less solvent EU nations to adopt the euro even if they had failed to fulfill the criteria outlined by Maastricht. Today, all EU member states—with the exception of the UK, Denmark, and Sweden—are required to join the eurozone when they meet the criteria. Entry to the eurozone is controlled by the so-called Eurogroup, which comprises the seventeen eurozone finance ministers ; the group has been led by Luxembourg Prime Minister Jean-Claude Juncker since 2005.

Following Maastricht, leaders of European countries with weaker economies tended to defer tougher budgetary measures because of domestic challenges. "The political price for those moves [mandated by Maastricht] was too high for countries like Italy, Spain, and eventually Greece, and they entered the euro without that deep restructuring," writes John Cabot University’s Pavoncello. The effects were not immediately felt : The periphery states thrived in the first years of the euro, propelled by large infusions of liquidity and unprecedented access to credit from other eurozone states. At the same time, the "productive capacity" of the periphery was limited by rigid labor markets and a reduction of economic competitiveness.

The underlying structural issues in the eurozone periphery became increasingly visible following the global financial meltdown of 2007-2008. Liquidity quickly dried up and several states were left with unsustainable deficits and public debts greater than their GDP. By 2010, a sovereign debt crisis—most pronounced in Greece—was spreading throughout the periphery and imperiling the future of the eurozone. Between spring 2010 and spring 2011, the EU and the IMF acted to bail out Greece, Ireland, and Portugal.

Sovereign Bailouts

Greece’s debt crisis came to a head because of its massive spending and consumption, coupled with increased wages and government benefits, in the years following its adoption of the euro. In November 2009, it was revealed that Greece had manipulated its balance sheets prior to the global financial crisis to hide its debt. As a spring 2011 report by George Mason University’s School of Public Policy (PDF) summed up : "The roots of Greece’s fiscal calamity lie in prolonged deficit spending, economic mismanagement, government misreporting, and tax evasion."

In May 2010, the European Commission, European Central Bank, and IMF held an emergency meeting to address Greece’s burgeoning debt crisis, which resulted in the creation of a temporary bailout fund called the European Financial Stability Facility. Following its inception, the EFSF helped to provide Greece with a $163 billion loan in exchange for assurances that the country would implement strict spending cuts and tax hikes.

By 2011, after three credit rating agencies downgraded Greece’s debt to junk status, it was clear that Greece was struggling to implement EU-IMF-mandated budget cuts and privatization plans. In October 2011, with Greece again on the verge of default, German Chancellor Angela Merkel and French President Nicolas Sarkozy engineered a three-pronged rescue plan to provide Greece with a second bailout package worth approximately $178 billion. Unlike the original bailout, the deal included a "voluntary" write-down by private holders of Greek debt.

However, the budget cuts mandated by the agreement triggered a political crisis in Greece that led to the resignation of Prime Minister George Papandreou and the formation of a so-called technocratic government of national unity, paving the way for the implementation of the new bailout. The terms of that agreement proved unrealistic and were renegotiated in November 2012, providing Greece with lower interest rates on its bailout loans and implementing a debt-buyback program. The new plan requires Greece to cut its debt-to-GDP ratio to 124 percent by 2020, rather than 120 percent, while committing to bring its debt levels "substantially below" 110 percent by 2022.

Still, an increasing number of analysts and policymakers doubt that the rescue will be enough to set Greece on the road to fiscal soundness. The IMF, for one, has called on Greece’s official creditors, including Germany and the ECB, to also take losses on their holdings of Greek debt.

Unlike Greece, Ireland’s debt crisis was spurred by a bank default crisis, a result of its housing bubble collapsing in 2008. In the wake of the global financial crisis, the Irish economy experienced one of the most severe recessions in the eurozone. According to the George Mason report, Ireland’s output decreased by 10 percent between 2008 and 2009, while unemployment increased from 4.5 percent in 2007 to nearly 13 percent in 2010.

Ireland’s government took on massive liabilities to support its financial system (WSJ) during the global crisis. In December 2009, the country’s finance minister announced a budget-reduction plan following warnings from the Organization for Economic Cooperation and Development that its deficit was ballooning to dangerous levels. Still, less than a year later, in November 2010, Ireland was on the verge of default and was forced to seek a $112 billion EU-IMF rescue package. In return, Ireland implemented a new budget aiming to cut $20 billion over four years through spending cuts and tax hikes.

Meanwhile, Portugal’s GDP, productivity, and wage growth stagnated over the past decade. The country’s dependence on foreign debt—demonstrated by a current account deficit that was more than 10 percent of GDP in 2009—made it more susceptible to the crisis sweeping the European periphery. Investors bet against Portugal, raising their premiums, and making it increasingly likely the country would not be able to finance itself in debt markets.

As Portugal’s debt crisis worsened in 2010 and 2011, its then-Socialist government tried in vain to implement numerous austerity packages, each rejected by parliament. By the end of March 2011—with Portugal’s credit rating at near-junk status and the yields on ten-year bonds more than 8 percent—it became clear that Portugal, too, would require a rescue loan. In May 2011, the EU and IMF agreed on a $116 billion bailout package, for which Portugal agreed to implement austerity measures totaling 3.4 percent of GDP. Still, in July 2011, credit rating agency Moody’s downgraded Portugal’s debt to junk status, warning of an "increasing probability" that the country could need another bailout. Since then, Portugal’s recently installed center-right government has taken pains to implement steep cuts, even as the country faces its deepest recession in decades.


At the end of 2011, the center of the debt crisis shifted to Italy—the eurozone’s third largest economy after Germany and France. Markets had lost confidence in Prime Minister Silvio Berlusconi’s ability to implement long-promised austerity measures, sending yields on ten-year government bonds well above the unsustainable level of 7 percent. When the borrowing costs of Greece, Ireland, and Portugal reached similar levels, those countries sought financial assistance from the EU and IMF. For Italy, which has a public debt worth $2.6 trillion—more than 115 percent of GDP—a bailout was not an option.

Italian political leaders forced Berlusconi to step aside and allow for the formation of a temporary technocratic government of national unity to carry out urgent budget reforms. By early 2012, Prime Minister Mario Monti had put forward billions in tax increases and spending cuts while moving to reform the pension system and a rigid labor market. He also sought to shift the discourse from one focused on austerity to a more growth-oriented approach. However, national parliamentary elections in February 2013 yielded a political stalemate. The leader of the center-left Democratic Party, which won a majority in the lower house but not the upper house, failed to form a coalition government, rattling markets and curbing Italy’s ability to address its mounting fiscal woes.

Meanwhile, Spain, which had a rapid increase in its budget deficit in the wake of the financial crisis, is also at risk of contagion. Like Ireland, Spain went through a major housing-market bust during the global financial crisis that left its banking sector highly exposed. By the summer of 2012, Spain was forced to request a bailout for its beleaguered financial sector. In July of that year, EU leaders agreed to use the eurozone bailout funds—the EFSF along with its permanent replacement, the European Stability Mechanism—to provide the Spanish government with $123 million in aid to recapitalize its struggling banks. Meanwhile, the 2012 haircut taken by private holders of Greek debt ultimately spurred a crisis in Cyprus’s bloated banking sector. Cyprus’s large holdings of Greek bonds lost most of their value, causing the country’s banks to become insolvent. In March 2013, Cyprus reached a $13 billion bailout agreement with the European Commission, ECB, and the IMF that required the country’s largest bank, Laiki, to be closed, while forcing heavy losses on wealthy bank depositors.

Reforming the EU

In the wake of the global financial and debt crises, the EU began to adopt measures for centralizing governance mechanisms and coordinating fiscal and economic policy. Most notably, in December 2011, EU leaders agreed to the formation of a so-called fiscal union. Twenty-five EU countries—all but the UK and Czech Republic—signed on to the German-engineered fiscal compact, allowing the EU to dictate the national budgetary policies of participating nations.

Eurozone leaders announced plans in the summer of 2012 to push forward with further integration by creating a single banking authority—to be situated in the ECB—as a first step toward developing a eurozone-wide banking union.

The ECB has arguably emerged as the most powerful eurozone institution in the wake of the crisis. In September, the bank unveiled a potentially unlimited bond buying program that allows it to buy up the government bonds of struggling euro countries on the secondary market. The move was meant to assuage markets and bring down the borrowing costs of indebted sovereigns, while providing governments space to implement fiscal consolidation policies.