The Euro and the problem of PIIGS (I)

Here I begin a series of posts analyzing the problem of the most "famous" countries of the West: the PIIGS.

PIIGS: the junction of the first letter of Portugal, Italy, Ireland, Greece and Spain.

It is an expression that already has a few good years of use but that since the beginning of the sovereign debt crisis in Europe has gained prominence as never before had acquired.

In fact, the problem of sovereign debt crisis has these five countries as the main stage.

The worst situation is obviously fa Greece currently has a debt as a percentage of GDP of around 160% and a deficit in the order of 6.7% of GDP (Forecasts for this year made ​​in late February 2012).

However, this country generally reflects what is happening in PIIGS: some more than others, all these countries have serious budget deficits, and structural problems more or less worrying.

Being the "poorest" in the club of the rich, it becomes very difficult for these countries can impose itself on the world economic context.

But to see how these countries, even after joining the most powerful economic bloc in the world, came to this catastrophic situation, I have to go back to the time when each joined the common currency.

With its accession to the Euro, it was easier to obtain loans for each country since Germany became the reference point in obtaining loans, which increased the confidence of the markets in all countries of the euro.

As the whole process of creation and implementation of the common currency was based on the credibility and robustness of the German mark, nothing compared to the instability and fragility of the currencies of PIIGS, this would eventually cause problems for these countries. The increases in prices, wages and other costs were generally higher than productivity gains.

Being under the same currency, the increasing divergence in costs between Germany and the PIIGS, led to an imbalance in real exchange rates and a worsening in the balance of current transactions in these countries while, on the contrary, the balance of Germany's relations with the outside had a growing surplus.

Moreover, the cost containment policy applied by the engine of the Eurozone during the first decade of this century, eventually worsen the balance of PIIGS with the outside.

Greece would become the exponent of these problems that have affected the euro area. Hence, the problems that can happen to this country, affecting not only the remaining PIIGS, as shakes the whole structure in which was mounted the single currency.

This crisis has also warned of the problem of, standing before a union only economic, not political also, there is a uniform monetary policy and exchange rate while there are numerous economic policies, either both in the way of managing economic activity in times of expansion and how to solve the problems of recession, as many as the member countries of the Eurozone.

The result was the continued deterioration in the budgetary situation and the high foreign debt. The low growth prospects for the coming years for these countries, have further aggravated the situation: the economy's growth will not contribute almost nothing to cover the budget hole.

The situation becomes more bleak when it notes that most debt securities of euro area countries is in the hands of banks in other countries that also belong to the eurozone.

This created a vicious cycle that makes it even more difficult the task of finding a way out of this chaotic situation: could not resort to monetary policy instruments, the threat of failure looms with such intensity leading to reduction of the value of debt securities of affected countries. With these bonds in the hands of banks, which already are indirectly affected by what happens in the state where they are, are directly affected by the loss of value of such securities.

The dream of flying PIIGS seems to be coming to an end.
Finding the reasons for this leads us to the years prior to its accession to the EURO.

And this loss that banks suffer ultimately affect the states where they are. And vicious cycle is created, which extended to the four corners of the world, thanks to another part of the public debt in the hands of banks and states outside the eurozone. To minimize these losses, banks outside the euro area also sell its assets to other countries.

In short, the whole world-system turns out to be affected by this crisis originating in the PIIGS.

After World War II, the 1st organization to include several European countries was NATO, which was under the influence of the USA.

In economic terms, was in 1957 that six European countries created a common market: the EEC. Italy was a founding member.

As for the remaining PIIGS, Ireland joined in 1973, Greece in 1981 and Portugal, along with Spain, in 1986. In 1992 the Treaty of Maastricht enshrined a single market for EU countries with free movement of persons, goods, services and capital between them. From then until the end of this decade has intensified the economic union between the Member States, and prepared to create a zone with a single currency, a common central bank and a single monetary policy.

However, ever since the 70s that tried to create a common currency for all members of the European common market, always failing.
The decisive steps for the creation of the single currency were the creation of the EMS (European Monetary System) in 1979 with the aim of creating between the Member States an area with stable exchange rates and prices (imposing limits to the fluctuation of the currencies of each country), and the consecration of the Delors Plan (1989) in the Maastricht Treaty, which established three essential steps for the creation of the common currency:

- Formulation of monetary policy by the European System of Central Banks (European Central Bank more Central Banks of each Member States);
- Harmonization of economic policies of each Member State by the European Commission and the Council of Ministers;
- Maintenance of price stability over the European Central Bank;

In 1994 was created the European Monetary Institute, in order to coordinate the monetary policies and to prepare the creation of the single currency, a process started officially on January 1, 1997. At that time, it was agreed that on 1 January 1999, would adopt the single currency the countries that met the following economic convergence criteria:

- The public deficit should not exceed 3% of GDP;
- Government debt should not exceed 60% of GDP;
- The inflation rate could not be more than 1.5% above the rate of the three countries with the lowest inflation;
- Interest rates on government debt in the long term, should not exceed by more than 2% the rate that applied in the same three countries (referred to in previous point);
- The exchange rate should be kept for two years, within the limits set by the SME may not occur any significant exchange rate depreciation or appreciation;

In short: to participate in the Economic and Monetary Union many countries had to change their economic policies, because it was necessary to verify the convergence of inflation and interest rates so that there is exchange rate stability, as well as a strong control over deficits and debt.

At the time of negotiation of the accession agreement, there were few countries that complied with these criteria. However, eleven countries have signed.
Greece was left out because, however much they tried to soften things, the situation in Greece was too far from acceptable.

The desire not to create a multi-speed and divided Europe, when it wanted the opposite, finally speak up, and these 11 countries have signed, since they undertook to satisfy the conditions of the convergence criteria, as well as they could.
By the end of 1996, would be set if the countries were able to begin its accession to monetary union. If so, it would make the creation of the ECB (European Central Bank) would start by dealing with the pre-launch of the euro, and the same issue.

The same countries that fueled the PIIGS, are now dropping them in the mud themselves.

Who does not fulfill the criteria, abandoned the accession process, going back to try again later.

According to economic theory, to find an optimum currency area is necessary to weighing the costs and benefits of participation for each country.
Germany and France joined the euro by a political question: even deny it, and come with the altruistic claims that Europe should be united and seen and treated as a whole, the euro has increased the supremacy and power of their economies .
As Denmark and Sweden, for different reasons, it seems that this unifying vision they went along (and maybe never have had as much reason as now). Already the UK, continues to behave like a mini-continent (it's a world apart ... admit).

What about the PIIGS? Not joined for political reasons.
Then weighed the benefits and costs, and concluded that the benefits were much greater than the costs (which were almost overlooked when it announced to the public the "wonders" of the single currency). Right? Wrong.

Returning to Economic Theory. In a monetary union may occur three types of benefits:
- Leaving there costs associated with foreign exchange, trade with the outside leaves favored, and therefore increases.
- The monetary integration leads to the integration of financial markets, which results in the implementation of a lower real interest rate (and it seems that everybody has seen good and never forgot this benefit);
- Especially for countries that do not have a central bank with a well-designed policy (that is, wandering), with monetary integration, the central bank gains credibility and strength to the political winds.

As these costs are summarized in the loss of monetary policy instruments and foreign exchange. Leaving there the interest rate, the monetary policy instruments in the hands of various countries, they they can no longer respond to any suffering shock.
Countries are thus limited to fiscal policy.

The whole scenario seems really exciting, especially for the countries of southern Europe. However, it was a specific group of these, known as PIIGS, which caused panic in the markets, leading to serious disturbances not only in their economies, as throughout the European Union.
What started out to be a serious case, but only restricted to Greece, is reaching gigantic proportions.


What happened then? I leave it to the next message.