Global Consequences from the European Financial Crisis

2/6/2012 1:34:00 PM


Professors at Johnson’s Emerging Markets Institute discussed ramifications of Europe’s financial turmoil, which has several nations at risk of defaulting on sovereign debt. The crisis represents not only a financial problem for member nations, but a political problem as well.


European policy makers have grappled with how to address the ability of Portugal, Italy, Ireland, Greece and Spain to meet their obligations. Some of their moves have succeeded, leading to cheaper/stabilized borrowing costs for Ireland, Italy and Spain in recent weeks. The fact that the nations use the euro provided these nations access to lower interest rates that belied their financial conditions before the crisis, but the nations don’t have their own currency and central banks to address their own economic difficulties.

Professors Chris Anderson, Edith Liu, and Andrew Karolyi recently spoke about the prospects of the financial crisis spreading beyond Greece, bailouts, political unrest and what can be done to address the crisis.

“This is a crisis of confidence. That’s what the Eurocrisis is,” said Karolyi, professor of finance and economics at Johnson, noting that the real concern is “financial market contagion.” Countries which fail to meet the debt parameters established by the Eurozone should be removed and thus forced to return to their own sovereign currency, he said.

Karolyi said the EU has the legal tools for nations to leave the euro, since the treaty can be amended.

Karolyi wanted to also make clear that the European Central Bank has overstepped its singular mandate for price stability as a result of this crisis and the $750 billion European Financial Stability Facility (EFSF) to provide loans to distressed euro nations has not yet raised the funds since the authority was created in June 2010.

Liu, an assistant professor of applied economics and management, shared that the focus needs to be on insulating
the banks and the banking system from government default. Professor Anderson, former director of the Cornell Institute of European Studies, offered that the EU needs to become a true political union to resolve the disparity between nations. Due to the structure of the EU, however, there will be a lot of talk and stalemate, but very little action, he said. Anderson expects a lot of civil unrest from unpopular austerity measures before the crisis is over.

Anderson maintains that the EU will not fall apart and that the problems can be solved by Europe despite the politics and drawn out process.

Portugal the next domino to fall?

Liu sees Portugal as the next nation to watch among euro zone countries. Many euro nations’ debt to gross domestic product ratios exceeded the European Union’s mandated 60 percent. Greece already topped that, but The Economist cites IMF forecasts that Portugal’s public debt will peak at 118 percent of GDP next year.

Professor Liu also believes there is a potential for bank runs in the Eurozone. U.S. financial institutions have already reduced their commitments to banks in the Eurozone, cutting 40 percent of overall funding and loans and investments by 85 percent.

Professor Karolyi suggested a “borrowed but good” idea to encourage much more sound economic decision making.

Politicians should be paid in bonds issued either by the EU or their own countries, instead of cash. Lawmakers from countries which adhere to the Eurozone financial parameters, such as debt-to-GDP ratios, would receive EU bonds.

Politicians from countries that fail to embrace financial discipline would instead receive bonds from their own country,
Karolyi said. With this approach, lawmakers would have to eat whatever their budgetary chefs have been cooking.
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