Europe Reinvents Itself: A Primer on the New Eurozone

Here's what Eurozone leaders did overnight to tackle their nearly two-year-old sovereign debt crisis and ensure the euro continues to be the proverbial tie that binds.

The problem

Nations along the southern rim of the Eurozone have for years been spending far more than they earn. The most egregious case is Greece, where the annual deficit is nearly 200 percent of its GDP. The reason that is a problem is because it makes it more and more expensive to borrow money. Whereas the U.S. or Germany can borrow money for 10 years and pay an interest rate of a mere two percent, Greece has to pay around 25 percent to do the same thing. Because Greece lacks the cash to service that kind of borrowing, it is in danger of defaulting on its now-massive national debt. In all, Eurozone nations have some $1.1 trillion in debts coming due next year, much of it carrying prohibitively high interest rates.

Long-term solution

  • After an all-night negotiation and bargaining session, leaders from the 17 nations in the current Eurozone, that is, the 17 countries whose currency is the euro, plus six others who aim to join the Eurozone agreed on Friday to give up some fiscal sovereignty. Those 17 nations will now draft a treaty, due March 2012, that obligates them to submit their annual budget to the European Commission for approval. It is expected that any budget's planned expenditures that exceed three percent of GDP will be rejected. The goal of this fiscal integration is to prevent any more sovereign debt crises such as now engulf Greece, Italy, Spain, Portugal and Ireland, and threaten numerous European banks that hold debts of those nations. Britain refused to surrender any fiscal sovereignty, while Sweden, the Czech Republic and Hungary plan to consult their parliaments before agreeing. While a fundamental structural change to the Eurozone, the benefits of Friday's summit will not be evident for years.

Short-term help

  • Central banks of Eurozone members agreed to make $267 billion in bilateral loans to the International Monetary Fund. European Union members that do not use the single currency agreed to lend the IMF $67 billion of the $267 billion. This money will go into a special IMF fund designed to provide cash for financially ailing Eurozone nations. It was the first time Eurozone central banks agreed to contribute to the IMF.
  • The summit ended the requirement that private sector involvement in buying Eurozone government bonds entail sharing the cost of bailing out the governments issuing those bonds. That provision, which had been championed by Germany, was deterring investors from buying Eurozone bonds. And with demand for such bonds low, yields on those bonds have soared to unmanageable levels. Bond yields will now be less likely to rise.
  • Although the European Central Bank decided Thursday to keep its purchases of Eurozone government bonds capped at about 20 billion euros per week, the fact that the Eurozone will become a fiscally integrated union led some officials to suggest the ECB will in fact boost bond purchases. Public comments Friday by ECB head Mario Draghi encouraged such expectations.

Intermediate-term help

  • Funding for the Eurozone's permanent bailout fund, the European Stability Mechanism, will be increased to $668 billion.
  • The ESM, which will be controlled by the European Central Bank, will begin functioning by the middle of next year, 12 months ahead of schedule.
  • The current, temporary rescue fund, which has $587 billion and is known as the European Financial Stability Facility, will continue to operate alongside the ESM for a year.
  • G-20 nations are now poised to contribute financial help to the Eurozone. G-20 official Sohn Byung Doo told Bloomberg, "We can contribute if some conditions are met."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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