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21 June 2012

Euro crisis: What’s going on?

Euro crisis: What’s going on?

Following the second election in as many months, a coalition government is due to be formed with Antonis Samaras as the new prime minister of Greece. The New Democracy party, which increased its share of seats but fell short of an overall majority, has reached an agreement with PASOK and the Democratic Left party to secure their support and enable the formation of a government.

The second election was called after the 6 May election failed to lead to a government. On that occasion, a majority of Greeks voted for parties that wanted to reject their bailout agreement with the EU and International Monetary Fund (IMF). The New Democracy party run on a platform accepting the need for further cuts, which were a condition of the latest bailout, however, they are expected to want extra time to introduce the stringent measures.

The result, and the successful formation of a government, will dampen fears that Greece was destined to exit the Euro. While none of the major parties were calling for an exit, had Syriza, the far left party which finished second, won power and rejected the EU and IMF measures, that prospect would have loomed closer on the horizon.

Without the cutbacks, which include reducing the minimum wage by 22 per cent and increasing the retirement age to 65, there was widespread fear that the Greek government would not be able to afford to repay the debt it has accumulated. The escalating situation in Greece comes at the same time as worry mounts about the sustainability of finances in other countries across Europe.

In recent months Spain has come under economic pressure as the cost of its debt has risen and its banks have requested a bailout from the government. In response Spain made a formal request for a loan from eurozone funds to meet these demands. Spain had not run the same level of budget deficit as Italy or Greece who both frequently failed to keep within the three per cent limit agreed in the 1997 Growth and Stability Pact.

The major problem for Spain’s finances stemmed from the dramatic fall in demand for housing since 2008. House prices rose 44 per cent between 2004 and 2008 as the culmination of a bubble that followed a long period of growth, with families taking on more debt in the form of mortgages. Since 2008 house prices have dropped by a quarter. The banks which had been thriving as the housing boom took off have now been crippled as borrowers default on their debt. These banks had also borrowed internationally to lend to developers to build new houses, many of which have never been completed, meaning repayment of the debt is even less likely.

In December 2011 the UK refused to agree to a new EU treaty which would enshrine strict budgetary rules. Prime minister David Cameron objected to the UK becoming drawn in to subsidise struggling countries in the eurozone, with criticism already aired at the costs of bailouts through existing EU and IMF mechanisms. The Church of England, in their submission to the Foreign Affairs Select Committee, criticised the government’s isolationist approach and warned of their waning influence: “That other countries, even non-eurozone states, are now willing to openly press ahead without Britain, even if that means working outside the formal structures of the EU, is symptomatic of Britain’s waning influence in Europe and its declining ability to cultivate allies in Europe.”

Germanyhas shouldered much of the economic burden across Europe and at present its economy continues to grow, however, chancellor Angela Merkel has stressed that there are limits to this capacity. Behind the scenes Merkel is considered to be pushing other European states to give Brussels further power over their national budgets. The G20 in Mexico committed to lowering the cost of borrowing, but reports suggested that Merkel had not agreed to using EU funds to achieve this through buying government bonds.

While it appears that Greece will for now remain in the Euro, the longevity of that relationship is in serious doubt. Leaders in Europe and across the world are currently eager to avoid a Greek exit because of the precedent it would set, and spark speculation that Ireland, Spain, Portugal and Italy’s future in the eurozone was on probation. The upshot of this speculation would be a loss of confidence in the ability of these countries to repay their debts, and subsequently the long-term government bonds would become more expensive, making their borrowing more costly and thus making their economic situation even worse. This is the downwards spiral that world leaders are desperately trying to avoid.

Find out more about how this crisis came about.