Ben Chu: What went wrong in the eurozone and why didn't bailouts fix it?

 

Greece had to be bailed out by the European Union and the International Monetary Fund two years ago because it had lost the confidence of the private financial markets.

The nation's national debt had risen to perilously high levels and Athens needed to raise billions of euros on the capital markets each year merely to roll over its borrowings. Plus the government had a large deficit, meaning it had to borrow still more each year merely to pay for its spending. Still worse, the economy was shrinking, making it more difficult for the state to raise more revenue to reduce its deficit.

Investors feared the country was heading for a default and that if they lent to Greece they would not get the money back. They desperately sold Greek debt, pushing down the price of its sovereign bonds and sending the effective borrowing rate of the Athens government spiralling. To prevent Greece going bankrupt, European leaders were forced to step in.

But Greece was only the start. The struggling economies of Ireland and Portugal also needed to be bailed out over the following year after they too lost the confidence of the financial markets. And now Spain and Italy also look increasingly vulnerable. Both have slumped into recession and have seen their interest rates rise since the middle of last year.

The problem now is that these two economies could be too big to save. This is because the stronger nations of the eurozone – led by the continent's economic powerhouse, Germany – have been doggedly resisting calls for them to commit more resources to the continent's common bailout fund.

It does not help that the European Central Bank has also refused to play an active role in stabilising the debt markets of struggling eurozone member states. Yet if the situation in Spain and Italy does not stabilise, Germany and the European Central Bank could be faced with a stark choice: act or see the eurozone break apart.

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