What Is The Euro Crisis? A simple explanation!
So what is the Euro Crisis?
The Euro crisis may seem a bit baffling to some but actually the Euro crisis is no different from the debt crisis being faced by millions of people today. Credit was made far too available and lent to people who couldn’t really afford to pay it back. Throw in some dodgy accounting and you have a perfect economic storm for the Euro.
Many people in western economies have recently found themselves in their very own debt crisis. Credit has been made far too available, at very low rates of interest, to people who are not really able to pay it back. This explosion of credit has engulfed many individuals and families who have gotten carried away, borrowing much more than they could afford, spending the money on luxuries that they also couldn’t afford!
When the Euro was formed it enabled many countries like Greece, Spain, Portugal & Ireland amongst others to borrow money at extremely low rates of interest, rates that had never been available to them in the past. These countries were taken along with the “good times” spending massive amounts of money on public sector workers, infrastructure and if we use Greece as a specific example, events like the Olympics. They simply borrowed much more than they could afford to pay back or even pay the interest on.
Borrowed too much! What now?
Everyone would agree that in theory when you’ve borrowed too much you should tighten your belt! The problem is when you’ve become used to a certain standard of living this is much easier said than done. People in the western world used banks, brokers and accountants to consolidate their debts (and in some cases manipulate the figures!). They took out bigger loans or mortgages and spread them over longer terms to make the debt repayments affordable. These people then learnt their lesson and stopped spending, right? Unfortunately not! It actually just enabled people to borrow even more money, and they did!
The countries currently engulfed by the Euro crisis fell into the same trap. Instead of tightening their belts some countries in the Euro, especially Greece used banks and accountants to find ways to hide their precarious debt situation. They managed to hide the amount of debt they were in so lenders still viewed them as credit worthy, allowing them to borrow even more and get into an even bigger mess!
When debt troubles come to light, rates go up!
As many people have realised regarding their own debt crisis eventually you run out of ways to hide or consolidate your debt mess! When you are finally seen to be over indebted, the sad fact is the situation can very quickly spiral out of control! Lenders don’t want to lend you money anymore. You can’t remortgage, consolidate or balance transfer your debts. The lenders that are willing to lend want higher rates of interest making your problems even worse!
This is what has happened to Greece and other overly indebted countries of the Euro! When it came to light just how big Greece’s debt problems were, lending to the country effectively froze! Those that would still lend money to Greece wanted higher interest rates exacerbating the problem! This meant Greece couldn’t refinance its debts and needed a bailout. The fears created in Greece then spread to other countries that were perceived to be risky.
So why is the future of the Euro in question?
Imagine the finances of everyone on the street in which you live are linked together. You live responsibly, work very hard and have a modest standard of living. Your neighbour however doesn’t work as hard as you, regularly buys flash new cars and holidays 3 times a year. Before long it comes to light that your neighbour is massively in debt and can no longer pay his debts. As the finances of everyone in your street are linked together, your neighbour then asks you to pay his debts for him! How would you feel about that?
As in this figurative street, all the countries of the Euro are interlinked financially. Some of the less responsible countries are now in trouble with their debts and are asking the more responsible ones to pay their debts for them.
You can see why this might not be a happy arrangement for the responsible countries! So why not just split up and go your separate ways?
If one country like Greece falls, it’s very possible that all the countries of the euro will fall with it. If they all fall, it’s also very possible the worldwide economy will be dragged down with it!
So again imagine that all the neighbours on your street are interlinked financially and are members of a joint bank. This bank holds your savings and uses those savings to provide risky loans and mortgages to your neighbours. A few your neighbours suddenly look likely to default on these risky loans. The financial problems this could cause for your joint bank might cause the bank to fail, taking your savings with it! Would you now chip in to help pay the debts of your irresponsible neighbours, if it worked in your favour financially, preserving your savings?
This is the biggest dilemma when considering a Eurozone break up!
Eurozone banks have lent so much money to the Eurozone’s indebted countries that if one or more of these countries were to leave the Euro and default on its debt, it could bring all the banks of the Eurozone and perhaps even the world banking system crashing down with it. This may sound like an exaggeration but it’s not. It could make the recent credit crunch seem like good times!
As things stand Eurozone leaders are desperately seeking to find a way to prevent this banking collapse!
I hope you can see from this basic explanation that the Euro crisis is very similar to the debt crisis being faced by millions today. The difference is that the finances of all the countries of the Euro are so interlinked, that if one country leaves and defaults on its debts the domino’s could soon start to fall sending the whole banking system crashing down with it.