The Financial Crisis of 2008, Research Paper Example

The financial crisis of 2008 severely affected the economic balance of the European Union. The past four years have been witness to an increasing fear of an additional European economic crisis. The crisis is referenced by the economic stability of the European Union has directly affected the nations of France, Belgium, Italy, Spain, Ireland, Portugal and Greece (Bonner, 2012; Baskaran & Hessami, 2011; Gärtner et al., 2011; Neely, 2012). The research thesis which will be reviewed is the default of the sovereign nations on short term sovereign nation loans and the implications for the future of the European Union.

The issue which has been the focus of the present European debt crisis is that the creditors purchased the short term notes from the European Central Bank with the hope that the European Union would effectively apply the proceeds from the sale of the government bonds in times of economic difficulty. The member European Union nations perceived that they had been protected by the European central bank’s ability of attracting speculative investors. The member nations of the European Union went under the assumption that the European central bank had the ability of printing unlimited amounts of cash (Bonner, 2012; Baskaran & Hessami, 2011; Gärtner et al., 2011; Neely, 2012).

These nations are facing an acute economic crisis which could spur extensive sovereign national loan defaults. The defaults in turn could spur increases in consumer inflation which would be the consequence of the defaulted short term loans. The nightmare of a sovereign nation defaulting on its loans is becoming a greater reality with respect to Greece and Ireland. The European Central Bank and the members of the European Union’ governments are struggling to balance the effects of the less economically capable European nations with the economies of Germany and France. These two economically dominant countries are endeavoring to compensate for the less economically capable nations of the European Union. As a result, Germany and France have witness a growth in their present national debts. The short term banking debt which is being maintained by Germany and France has a 24 month term of repayment (Bonner, 2012; Baskaran & Hessami, 2011; Gärtner et al., 2011; Neely, 2012).

The default of the government bonds which were promoted by the European Central bank on behalf of the sovereign member nations would result in a disaster for the global financial system. The ninety most extensive banks in Europe are holding onto $6.7 trillion or 4.7 Euros of short term notes which must be remitted within twenty four months’ time. The $6.7 trillion dollars is approximately fifty percent of the European gross domestic product of the seventeen sovereign member nations combined (Neely, 2012).

The present economic context of this situation is not without a solution. In the absence of new policies and swift effective action, the financial crisis in the European Union has the potential of resulting in the economic isolation of some of the governing nations of the European Union. This result may have the outcome of the dissolution of the euro as a currency. The present European debt crisis was caused by the application of short term borrowing by emitting bonds from the European Central Bank. A misrepresentation of the stability of these bonds was given to speculative investors (Bonner, 2012; Baskaran & Hessami, 2011; Gärtner et al., 2011; Neely, 2012).

Many of the speculative investors in the Euro bonds perceived that purchasing the short term notes was more effective that purchasing long term government bonds. At first the European Central Bank provided the same treatment to all of the member nations of the European Union. Their credit was assumed to be good. This perspective motivated the banks to purchase the long term loans and to use the short term notes as collateral for borrowing funds. This lending perspective was promoted by the bank to the speculative investors. The speculative investors were encouraged to purchase the short term notes as they were assured that the short term notes could be applied as collateral for borrowing funds. The government notes were created by the European Central Bank and possessed a high liquidity due to high consumer demand (Bonner, 2012; Baskaran & Hessami, 2011; Gärtner et al., 2011; Neely, 2012). There are three potential risks to this plan.

The plan caused an increased market demand for the bonds of the European Union member nations which were less economically dominant. This implementation caused a substantial amount of national debt to be incurred by the nations who the bonds represented. The speculating investors were given privileges of depositing the funds in the banks and using the short term notes which were issued against the economies of the less economically capable European Union member nations. This in turn created increased debt against the short term notes which were applied as collateral for the loans which were issued to the speculative investors (Bonner, 2012; Baskaran & Hessami, 2011; Gärtner et al., 2011; Neely, 2012).

In this scheme, a default by the member nations on their bond obligations would produce a domino effect, causing the loans which were issued to the speculative investors to go into default, as the value of the notes decreased in value. Consequently, in the beginning of the year, three of the largest global banks, Santander bank, Unicredit and Société Général have experienced severe decreases in the value of their corporate stock. The financial regulations of the European Union demand that the debt which has been incurred by a member nation musty not be in excess of three percent of the sovereign nation’s gross domestic product. Greece has manifested a debt index which amounts to 12.7% of its national gross domestic product (Gärtner et al., 2011; Neely, 2012).

The circumstances which are being experienced by the Greek administration are causing many of the nations of the globe to review their economic policies in decreasing their debts. The diminishing of debt would have the outcome of diminishing the demand for all categories of products and services, particularly expensive items such as those produced in the United States. There have been substantial variations of the value of the euro in comparison with the U.S. dollar. Should the euro continue in its downward spiral due to a lack of consumer confidence, the member nations of the European Union will be compelled to spend more money in order to receive exported products from the U.S. A potential future scenario for the nations of Belgium, Portugal, Spain, Greece, Italy and Ireland is that austerity plans must be placed into effect. If the debt crisis should spread, the price which would be required for all types of products would go up and become less likely to be consumed (Bonner, 2012; Neely, 2012).

The economic dominance which had been once held by the European Union nations and the United States has become secondary to the economic influence which is wielded by China, India, Brazil and Russia. Many of the perspectives regarding Greece are that Greece must be released from its membership in the European Union. This implies that with regards to the adopting of economic measures, Greece is not in alignment with the more economically developed member nation economies of France and Germany.  The problems for the investors are that as the bonds are international, there is no recourse to litigation should the Grecian bonds go into default and lose their value (Baskaran & Hessami, 2011).

This occurrence has been experienced by the United States and Europe in the past. The hope is that during the next few years that the redeveloped fiscal policies can provide remedies to the increasing debt crisis which is occurring in Europe. If these policies and actions are not swiftly implemented, the result of the default of the sovereign nations on their bond obligations may have the outcome of a recession which will extend past the border of the nations of the European Union. The outcome of the European debt crisis will be a more robust economic stance of the United States’ dollar as many investors will seek a currency which is stable and which has a lower potential of being affected by the European fiscal crisis (Neely, 2012).

Conclusion

The European debt crisis has the potential of creating a domino effect should the member nations against which the bonds are issued go into default on their obligations. Greece and the economic situation which has been created by the issuance of short term government notes has demonstrated that one member nation’s lack of economic ability to maintain an assertive fiscal policy can affect all of the members of the European Union. The implications for a default of one of the member sovereign nations are significant. If the nations of Portugal, Ireland, Italy and Spain follow the model which has been established by Greece, the result may be a global recession. The economies of Germany and France have become unbalanced by the European fiscal crisis. The economy of the United States is imperiled due to the aspect of a lower euro and a more elevated valuation of the United States dollar. Austerity measures must be put into effect in order to ensure that the European fiscal crisis remains contained within Europe. The aspect of the European debt crisis has caused many governments to review their fiscal policies. Perhaps the aspect of fiscal responsibility is one of the assertive outcomes of the European debt crisis. Will the European debt crisis create a global recession? Only time will tell.

References

Baskaran, T., & Hessami, Z. (2011). A tale of five PIIGs: Soft budget constraints and the EMU sovereign debt crises. Working Paper Series 2011(45), Department of       Economics, University of Konstanz.

Bonner, B. (2012). Turning into PIIGS: Why France’s debt crisis could doom the EU. Daily Reckoning, 24 July 2012.

Gärtner, M., Griesbach, B. & Jung, F. (2011). PIGS or Lambs? The European Sovereign debt crisis and the role of the rating agencies. Discussion Paper 2011(6), School of Economics and Political Science, Department of Economics, Universität  St. Gallen.

Neely, C. J. (2012).The European debt crisis and its implications for the United States. Federal Reserve Bank of St. Louis.