The Euro in Crisis

NW Brown Chief Executive looks at the reasons for the economic crisis in Europe, and puts forward his ideas on how it could be resolved.

As the fate of the Euro hangs in the balance, Marcus Johnson, CEO, NW Brown Group Ltd, puts forward his views on the crisis and suggests a way forwards.

The creation of a single European currency was intended to make trade easier, and allow organisations within the Euro Zone to operate across borders in a way they had previously been unable to do. To begin with, all seemed well, but the 2007/8 financial crisis exposed the cracks in the system.

The Euro Stability Pact was designed to deal with the need for a common policy by committing each government to running a deficit of less than 3% of GDP, and do having a maximum borrowing of 60% of GDP. All went well until in 2003/4 it became apparent that both Germany and France, the main authors of the Pact, were going to break the 3% limit. Fatefully, and possibly fatally, they decided not to follow the enforcement procedure of the Stability Pact and to ignore the deficits created by their overspending. In theory the Pact limits remained, but from that point on governments were no longer subject to an enforced limit.

At the time of the creation of the Euro it had seemed somewhat miraculous that Italy had managed to meet the criteria, and when Greece joined there was similar astonishment. What we now know is that the way they pretended to cut their deficits was in many cases short term fixes which left longer term problems for future years. So, for instance, very creative swaps of future revenues for current income were counted as reducing the deficit and one off tax acceleration and Public Private Partnerships played a large part in massaging Greek numbers downwards in the critical pre-accession year.

Standards of government accounting can be dubious, and the figures produced by the applicant governments were not subject to rigorous audit and so, like most governments most of the time, the Greek Government lied about the numbers. This was not a problem until the banking crisis of 2007/8 brought government debt levels sharply into focus as the banks (who had been expanding their exposure to governments as the counter part of the governments' expanding deficits) required massive government bailouts and questions began to be asked (particularly with reference to Ireland and Iceland) as to whether the governments themselves could afford the bailouts.

Once questions were asked, the extent of the previous deception became apparent. Governments now faced lower tax revenues as economies shrank at the same time as the spotlight focused on their deficits. Then in 2010 the new Greek government believed it was inheriting a deficit of 3.5% and rapidly recalculated to discover it was over 10%. To remove such a deficit in the short term is close to impossible. To finance borrowing of 160% of GDP is also demanding and the fact that Greece is a member of the Euro area makes these problems to some extent the problem of other members as well.

So what is the situation? Download the full article.