The Eurozone: What Impact Will It Have on the US?

In spite of how slow or bad our economy seems, we are still the only developed economy in the world that has a higher GDP now than it did before the 2008 crash.  The largest industrialized economy, in terms of population, is the Eurozone.  As interconnected as the world economies are now, it is important to see what is happening in other places to see how this may impact our lives.

The Eurozone was created at the end of the 1990s.  Seventeen of the 27 European countries are in the European Union (EU).  The original structure seemed great for all these countries to ban together with a common currency, common contracts and a common economy.  But, the set-up is deeply flawed, and fixing this, if it happens, will take decades. 

The first problem is that the EU joined together good credit risk countries like Germany with poor credit risk countries like Greece.  At the time of the start of the EU, Germany could borrow around 3.5% while it was nearly 14.5% for Greece.  The Greeks have gone bankrupt every 25 years or so after they won their independence from the Ottoman Empire.  In the old days before the Euro, when a country went bankrupt, they could devalue their currency to a point that made sense and still continue doing business.  With the EU, all countries, from the Germans to the Greeks and all those in between, can now borrow at the former German rate.  Prudent financial management would dictate that countries with higher interest debt could refinance this for lower rates.  Foolish financial management means countries that could not borrow in the past, can now borrow to do anything they want.  In the case of several of the EU countries, this is like lining the table with vodka shots in front of an alcoholic.

The creation of the Euro led to a larger bubble than we had in the US.  Spain’s real estate bubble was 2.5xs as large as we had here.  The Netherlands had the 2nd largest housing boom in the EU.  The Euro also led to rampant borrowing for social welfare benefits, pensions and private borrowing in most EU countries.  This happened, as many ignored the need to increase productivity.  As such, the cost of production shot up.  Germany has some of the highest paid workers in the world, but they are also some of the most productive.  In France, the employment taxes a company pays is 50% of the salaries they pay their workers.  So even though it is higher to pay German workers, it is still cheaper to make stuff in Germany than it is in France.  This has led to uncompetitive cost of production relative to Germany and the rest of the EU.

The EU now has a banking system that is nearly insolvent.  Almost every EU bank would fail the capital requirements that are imposed on US banks.  This is from bad European house loans, bad purchases in US mortgage-backed securities and bad European sovereign debt.  In Europe, 80% of national debts are lent and held by the banks, as they do not have as sophisticated of a capital market system as the US.

The EU is also faced with governments having exploding debt obligations.  This is a lesson for the US.  As austerity measures of higher taxes and lower government spending will be forced on the countries of France, Spain, Portugal, Ireland, Italy and Greece, this will cause their economies to spiral further into recession and default, as these cures are being applied.  This will impact the world as the largest country that China exports to is the EU. 

Of all the countries, watch France.  The French government controls the banks and has forced banks to lend to insolvent and bankrupt companies.  There is lots of delusion in France with their leaders spending even more money for more social programs than before.  Their current administration immediately cut the retirement age to 60.  They have since raised it to 62 to try to salvage the pension system. 

The EU has a lot of lessons that the US can learn.  Explosive government spending, massive social programs and a lack of financial restraint lead to gigantic amounts of debt.  This debt can starve a country’s economy and prosperity for years.