The credit crunch for dummies
Every day in the news, in the media, we hear about the credit crisis and the austerity measures to boost growth.
You haven’t taken the bandwagon and honestly, you don’t understand anything anymore.
Here is a quick overview to get you up to date.
The financial crisis in Europe
The findings are clear: unemployment in Europe today reaches almost 11% of the working population, a record. Each month, in addition to the current rate of job losses, there are almost 200,000 more unemployed. In France, for example, nearly 1,500 people lose their jobs every day …
Coupled with this, it should be added that many European countries, as well as the whole of Europe, are in recession, that is to say that growth has been negative for at least two consecutive quarters. Greece, for example, has been in recession for more than 5 years …
Origin of the crisis
We must distinguish three origins to this major financial crisis that began in 2008:
- Poor management of public finances: in fact, the sovereign debts of the member countries of Europe increase every year. For many countries, this public debt reaches almost 100% of GDP. Some countries such as Italy and Greece show fiscal deficits of more than 120% of the GDP. The origin of these deficits lies in the low level of public revenue compared to the operating costs of the States. In summary, European countries are spending too much. They live beyond their means.
- Collapse of the real estate markets and the poor financial health of certain banks: the credit crisis comes mainly from the United States but also from Spain. These two countries have in common to have speculated on the limitless increase in real estate markets. Unfortunately, the real estate markets have collapsed. Thus, the US and Spanish banks lent a lot of money to borrowers who could not afford to acquire real estate of the proposed value. These banks have thus speculated on the increase in real estate markets to compensate for the financial risk in the event of default. Borrowers could no longer repay their loans and some banks had to record financial losses thus putting them on the verge of bankruptcy.
- Financial speculation by the banks: many banks – and almost all the banks – have speculated with the poor financial health of the southern member states of the Economic Union. They massively bought bonds from countries in difficulty, the securities of which offered in return significant returns, in particular securities of the Greek debt. However, this is what happened to Greece and to save this country, it had to be granted gigantic reductions in its public debts. This is exactly what happened to Cyprus, which had massive amounts of Greek paper. Unfortunately, these banks never imagined that a country could go bankrupt and default.In other words, the Greek bond holders saw their debts reduced by almost 70%, which once again precipitated the banks, holders of these titles, on the verge of bankruptcy.
There are essentially two consequences to this delicate situation.
- Public deficits must be reduced in the countries of Europe. In summary, European countries should try to generate revenues above their costs, which is not currently the case.
- Banks in major financial difficulties must be refinanced. Indeed, the banks being the engine of the economy, if these banks no longer have liquidity, they can no longer lend money to the real economy and it is then the whole chain of production-consumption that is affected. Currently, this is the case and this explains the situation of recession.
Austerity or revival?
To stem this situation, two policies face each other:
- Austerity policies which essentially consist in reducing state spending and increasing public revenues through new tax levies and by reducing social benefits.
- The policies to revive economic activity which would consist in favoring the production tools to revive economic activity, decrease unemployment and generate new tax revenues.
What future for which Europe?
Europe has gone far too far in its social policy and the social model on which it prides itself so kills its competitiveness compared to other regions of the world. Under these conditions, the temptation for industrialists to relocate their production is great and this leads to the closings of factories and businesses that we know of.
To become competitive again, Europe will have to adapt to the realities of other regions of the world without which it is doomed to become an industrial and social cemetery.
Operating this economic, social and political transformation in Europe could well last at least 15 years – notably because of the power of the unions and the complexity of our labor codes – enough to probably put a generation of workers in difficulty.