Some historical context

Hey guys-

As important as going forward is, and as we contemplate who should do what in the European debt crisis, it is imperative to understand what's going on, and what has happened to get us to this point.

Let's start with the basics. CBC published an article today which acts as a primer. Some notable points from the article are:

• The euro, a common currency was adopted by 17 of the 27 member states of the European Union ("EU")

• Any country that enters the EU must adopt the euro once it meets the necessary criteria (Denmark and the UK have opted out of the euro completely)

• The "eurozone" refers to the 17 states that have adopted the euro in replacement of their old national currencies

• The Maastricht Treaty in 1993 lays out five main criteria to join the eurozone:

1. Inflation: the rate of inflation may not be more than 1.5 percentage points above the average rate of inflation of the three EU member states with the lowest inflation over the previous year.

2.Budget deficit: national budget deficits must be at or below three per cent of GDP.

3. Public debt: national public debt must not exceed 60 per cent of GDP. A country can still join if its debt exceeds this level provided it is falling steadily.

4. Interest rates: long-term interest rates must not vary by more than two percentage points from the average interest rates of the three EU member states with the lowest inflation over the previous year.

5. Exchange rates: exchange rates must remain within the accepted margin of fluctuation laid out in the Exchange Rate Mechanism (ERM) for two years prior to entry. (The ERM is the mechanism by which EU members linked their currencies in order to prevent large fluctuations prior to the adoption of the euro.)

If you read (highly recommended) - Michael Lewis' Boomerang, or read any news articles, it is apparent that in reality items like budget deficit and public debt are not met by several nations. In fact, in Boomerang, it suggests that Greece never met these criteria, but rather did a little 'cooking of the books' in order to grant access into the eurozone.

The European Commission estimates that the average debt burden for the euro area will be 88% of GDP in 2011 and 90.4% in 2012 (umm... wasn't the limit 60%?) Germany, the eurozone darling is forecasted to have debt of 81.7% of GDP in 2011, with Greece coming in at 150.9% of GDP. In reality deficits for the euro area are expected to be 4.1% of GDP in 2011, and 9-10% in Greece.

• While not all countries in the EU are not part of the eurozone, they are all part of a common market (no trade barriers, custom tariffs, border controls, and other impediments to the movement of goods, capital, labour and services across national borders)

• Today, the EU has common policies beyond trade (has included social and environmental co-ordinated reform), but the economic and core political integration was never structured

The open markets have lead to increased reliance between the EU countries (not only in the eurozone). The problem with just letting a country default, is the contagion impact not only in the EU but around the world. Some economists predict that a serious chain of defaults could spur a deep world wide recession. So as time is ticking, the economy (globally) becomes increasingly more fragile. For example, the China is the EU's 2nd largest trading partner after the US (we'll talk about China another week).

Michael Lewis gave a great interview on Charlie Rose which highlights the ridiculous nature behind the events leading up the debt crisis, and how the debt crisis isn't a singular banking crisis, or corruption of the financial systems. Rather in each country (Greece, Ireland, Iceland etc.), the underlying issues that lead to inflated debt-to-GDP ratios were culturally rooted. This would suggest that since the reasons for the crises were cultural traits and values carried on since... well the Greeks have been around since... forever (if the date has BC in it, I consider it to be forever), and that perhaps the solution won't be solved overnight (heck, my dad's only in his 50's and still he is stubborn as truck - honestly, try to talk him out of doing something once he's already set it in stone in his head. I dare you.)

Anyway, the book not only gives a great background but is funny (yes, actually funny). To give you a little teaser, the word feces appears a lot. If that doesn't get you running out to the bookstore, I don't know what will.

Link below to interview:

http://www.charlierose.com/view/content/11924