EURO CRISIS Introduction:

What constitutes a crisis? Is it sustained economic decline, high and long-term unemployment, poverty, rampant inflation, a precipitous fall in the exchange rate, fiscal deficits, high borrowing costs and political dysfunction? Most would agree that a crisis exists if just some of these "misery indices" are present. But while Europe is widely perceived to be in the grip of crisis, only a handful of them are present and in only a few euro-zone countries.

So why is there a euro-zone crisis and what defines it?

Time and again, it is argued that the single currency does not fit the different needs of its member countries and that unsustainable economic divergence will ultimately require that the euro be abandoned. Two key problems: Debt and deficits Lost competitiveness

The fatal divergences that are most frequently cited include differences in growth rates, job creation and unemployment rates, as well as dramatic disparities in current-account balances, all of which may be traceable to wide deviations in unit labor costs. Perceptions of such divergences force considerable risk premiums on problem countries, inevitably resulting in accelerating capital flight to safe havens.

The current Euro zone sovereign debt crisis was triggered two years ago when the Greek government revealed that its budget deficit for 2009 would be 12.5% of gross domestic product, substantially higher than the 3.7% predicted earlier in the year.

Since then markets have focused increasing attention on the magnitude of sovereign debts in other Eurozone countries and have started to question their ability to repay. The cost of borrowing relative to the German benchmark Bund has rocketed for Greece, Portugal and Ireland and is increasing for Italy and Spain. Greece, Portugal and Ireland have requested financial assistance from the troika the European Central Bank (ECB), the European Commission and the International Monetary Fund (IMF) and there has been an endless stream of European summits discussing ways to resolve the crisis. None has so far succeeded. At the present time, Greece and its creditors are negotiating a default of around 50% of its sovereign debt through the restructuring of repayments on sovereign bonds. Meanwhile investor confidence appears to be ebbing away from the larger economies of Italy and Spain, who are seeing their borrowing costs rise.

The European debt crisis is the shorthand term for Europes struggle to pay the debts it has built up in recent decades. Five of the regions countries Greece, Portugal, Ireland, Italy, and Spain have, to varying degrees, failed to generate enough economic growth to make their ability to pay back bondholders the guarantee it was intended to be. Although these five were seen as being the countries in immediate danger of a possible default, the crisis has far-reaching consequences that extend beyond their borders to the world as a whole. In fact, the head of the Bank of England referred to it as the most serious financial crisis at least since the 1930s, if not ever, in October 2011.

This is one of most important problems facing the world economy, but it is also one of the hardest to understand. Below is a Q&A to help familiarize you with the basics of this critical issue.

Q: How did the crisis begin?

The global economy has experienced slow growth since the U.S. financial crisis of 2008-2009, which has exposed the unsustainable fiscal policies of countries in Europe and around the globe. Greece, which spent heartily for years and failed to undertake fiscal reforms, was one of the first to feel the pinch of weaker growth. When growth slows, so do tax revenues making high budget deficits unsustainable. The result was that the new Prime Minister George Papandreou, in late 2009, was forced to announce that previous governments had failed to reveal the size of the nations deficits. In truth, Greeces debts were so large that they actually exceed the size of the nations entire economy, and the country could no longer hide the problem. Investors responded by demanding higher yields on Greeces bonds, which raised the cost of the countrys debt burden and necessitated a series of bailouts by the European Union and European Central Bank (ECB). The markets also began driving up bond yields in the other heavily indebted countries in the region, anticipating problems similar to what occurred in Greece.

The current events affecting bond market performance:

Q: Why do bonds yields go up in response to this type of crisis, and what are the implications?
The reason for rising bond yields is simple: if investors see higher risk associated with investing in a countrys bonds, they will require a higher return to compensate them for that risk. This begins a vicious cycle: the demand for higher yields equates to higher borrowing costs for the country in crisis, which leads to further fiscal strain, prompting investors to demand even higher yields, and so on. A general loss of investor confidence typically causes the selling to affect not just the country in question, but also other countries with similarly weak finances an effect typically referred to as contagion.

Q: What did European governments do about the crisis?

The European Union has taken action, but it has moved slowly since it requires the consent of all 17 nations in the union. The primary course of action thus far has been a series of bailouts for Europes troubled economies. In spring, 2010, when the European Union and International Monetary Fund disbursed 110 billion euros (the equivalent of $163 billion) to Greece. Greece required a second bailout in mid-2011, this time worth about $157 billion. On March 9, 2012, Greece and its creditors agreed to a debt restructuring that set the stage for another round of bailout funds. Ireland and Portugal also received bailouts, in November 2010 and May 2011, respectively. The Eurozone member states also created the European Financial Stability Facility (EFSF) to provide emergency lending to countries in financial difficulty.

The European Central Bank also has become involved. The ECB announced a plan, in August 2011, to purchase government bonds if necessary in order to keep yields from spiraling to a level that countries such as Italy and Spain could no longer afford. In December 2011, the ECB made 489 ($639 billion) in credit available to the regions troubled banks at ultra-low rates, then followed with a second round in February 2012. The name for this program was the Long Term Refinancing Operation, or LTRO. Numerous financial institutions had debt coming due in 2012, causing them to hold on to their reserves rather than extend loans. Slower loan growth, in turn, could weigh on economic growth and make the crisis worse. As a result, the ECB sought to boost the banks' balance sheets to help forestall this potential issue.

Although the actions by European policy makers usually helped stabilize the financial markets in the short term, they were widely criticized as merely kicking the can down the road, or postponing a true solution to a later date. In addition, a larger issue loomed: while smaller countries such as Greece are small enough to be rescued by the European Central Bank, Italy and Spain are too big to be saved. The perilous state of the countries fiscal health was therefore a key issue for the markets at various points in 2010, 2011, and 2012.

Q: Why is default such a major problem? Couldnt a country just walk away from its debts and start fresh?
Unfortunately, the solution isnt that simple for one critical reason: European banks remain one of the largest holders of regions government debt, although they reduced their positions throughout the second half of 2011. Banks are required to keep a certain amount of assets on
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their balance sheets relative to the amount of debt they hold. If a country defaults on its debt, the value of its bonds will plunge. For banks, this could mean a sharp reduction in the amount of assets on their balance sheet and possible insolvency. Due to the growing interconnectedness of the global financial system, a bank failure doesnt happen in a vacuum. Instead, there is the possibility that a series of bank failures will spiral into a more destructive contagion or domino effect.

The best example of this is the U.S. financial crisis, when a series of collapses by smaller financial institutions ultimately led to the failure of Lehman Brothers and the government bailouts or forced takeovers of many others. Since European governments are already struggling with their finances, there is less latitude for government backstopping of this crisis compared to the one that hit the United States.

Q: How has the European debt crisis affected the financial markets?
The possibility of a contagion has made the European debt crisis a key focal point for the world financial markets in the 2010-2012 period. With the market turmoil of 2008 and 2009 in fairly recent memory, investors reaction to any bad news out of Europe was swift: sell anything risky, and buy the government bonds of the largest, most financially sound countries. Typically, European bank stocks and the European markets as a whole performed much worse than their global counterparts during the times when the crisis was on center stage. The bond markets of the affected nations also performed poorly, as rising yields means that prices are falling. At the

same time, yields on U.S. Treasuries fell to historically low levels in a reflection of investors "flight to safety."

Q: What are the political issues involved?

The political implications of the crisis are enormous. In the affected nations, the push toward austerity or cutting expenses to reduce the gap between revenues and outlays has led to public protests in Greece and Spain and in the removal of the party in power in both Italy and Portugal. On the national level, the crisis has led to tensions between the fiscally sound countries, such as Germany, and the higher-debt countries such as Greece. Germany pushed for Greece and other affected countries to reform the budgets as a condition of providing aid, leading to elevated tensions within the European Union. After a great deal of debate, Greece ultimately agreed to cut spending and raise taxes. However, an important obstacle has been Germanys unwillingness to agree to a region-wide solution such as the issuance of bonds by all 17 countries in the Eurozone since it would have to foot a disproportionate percentage of the bill.

The tension has created the possibility that one or more European countries would eventually abandon the euro (the regions common currency). On one hand, leaving the euro would allow a country to pursue its own independent policy rather than being subject to the common policy for the 17 nations using the currency. But on the other, it would be an event of unprecedented magnitude for the global economy and financial markets. This concern contributed to periodic weakness in the euro relative to other major global currencies during the crisis period.

Q: Is fiscal austerity the answer?

Not necessarily. Germanys push for austerity (higher taxes and lower spending) measures in the regions smaller nations is problematic in that reduced government spending can lead to slower growth, which means lower tax revenues for countries to pay their bills. In turn, this makes it more difficult for the high-debt nations to dig themselves out. The prospect of lower government spending has led to massive public protests and made it more difficult for policymakers to take all of the steps necessary to resolve the crisis. In addition, the entire region slipped toward a recession in late 2011 due in part to these measures and the overall loss of confidence among businesses and investors. Nevertheless, Europes richer countries have little choice but to pressure the smaller nations to tighten their belts since they are facing pressure from their own citizens. Taxpayers in countries such as Germany and France balk at using their money to fund what is seen as the overspending of Greece and the other troubled European countries. This type of fundamental, high-level disagreement has made a solution more difficult to achieve.

Q: From a broader perspective, does this matter to the United States?

Yes The world financial system is fully connected now meaning a problem for Greece, or another smaller European country, is a problem for all of us. The European debt crisis not only affects our financial markets, but also the U.S. government budget. Forty percent of the International Monetary Funds (IMF) capital comes from the United States, so if the IMF has to commit too much cash to bailout initiatives, U.S. taxpayers will eventually have to foot the bill.
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In addition, the U.S. debt is growing steadily larger meaning that the events in Greece and the rest of Europe are a potential warning sign for U.S. policymakers, particularly with the "fiscal cliff" looming at the end of this year.

What is the outlook for the crisis?

As of May 2012, Europe remains in turmoil. Greece's exit from the euro appears inevitable; according to Bloomberg, Citigroup economists see a 75% chance that Greece could leave the euro after its elections later in the year, since the elections would likely lead to a rejection of the country's latest bailout package. In addition, over 50 percent of investors surveyed by Bloomberg News predict an exit of a euro member at some point in 2012. Instability continues to affect the rest of Europe as well: French President Nicolas Sarkozy lost power due in part to his support for austerity measures, and the region had fallen into a recession. Spain, for its part, faces 25% unemployment with no clear path to growth. European policymakers - who already lack unity face a difficult choice: keep the currency union together, with all of the challenges that would entail, or allow Greece (and possibly Spain and/or Italy) to exit, a path that would likely lead to financial market chaos. As a result, the chance of a further economic shock to the region - and the world economy as a whole - is still a significant possibility, and will likely remain so for several years.

Euro-area exposure AREAS AFFECTED BY EURO

Britains economy sank further into recession in the second quarter of 2012. Some blame this on an extra days holiday and bad weather, but Britain is also reeling from spending cuts and the fallout from the crisis in the euro area, where another recession looms too. According to Maplecroft, a research firm, Britain is the most exposed country to the euro crisis, given its close economic integration with the region, which is its main trading partner. Britains banks are also heavily exposed to euro-area debt. Some African nations are among those most at risk because of their trade dependence on the region. The BRICs (Brazil, Russia, India and China) fare better, but are still far from immune to the areas woes.

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Europes leaders climb slowly upward, but all too often are then dragged back down

THE euros agony is coming full circle. What started as a banking crisis mutated into a debt and then an economic crisis. Now, in Spain and Cyprus (and perhaps next in Slovenia), it is back to the banks. Europes banking woes never went away: they were just ignored or hidden. Whereas America acted quickly to repair its banks, Europes leaders are still arguing about how to fix theirs. Their delay is one reason the euro crisis keeps worsening.

Better late than never, the European Council on June 28th and 29th recognized that weak banks and weak governments were pulling each other down. We affirm that it is imperative to break the vicious circle between banks and sovereigns, the European Unions leaders declared.

They resolved to create a single bank supervisor for the euro zone (based on the European Central Bank) and then to allow the euros rescue funds to inject cash directly into ailing banks. This would alleviate the burden on Spain and maybe Ireland as well.
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The markets rejoiced, briefly. But as so often in this game of snakes and ladders, the leap up was followed by a slide down. Within days Spanish bond yields had again crossed the 7% threshold. For that, blame EU leaders love of bickering. Italy claimed victory in a deal to allow the rescue funds to buy its bonds and hold down borrowing costs with few strings attached. The Dutch disputed this. Finland demanded collateral; later it seemed to muse about leaving the euro (officials say comments by Jutta Urpilainen, the finance minister, were mistranslated). For one senior euro-zone figure, these two hawks have become emmerdeurs (a fruitier French word for pains in the arse). Meanwhile, Germany and the European Commission contradicted each other over whether Spains government would be liable for bank losses once rescue funds took over bank recapitalization.

Perhaps the biggest reason for the neglect is that the first euro explosion took place in Greece, caused by public profligacy. For Germany, especially, the cure became to enforce fiscal discipline. EU leaders have spent most of the past two years designing new rules and penalties to curb budget deficits and reduce debt. Ireland, with its banking crash, was treated as an outlier, a victim of unregulated Anglo-Saxon capitalism. The mood only began to change once the crisis hit Spain, a country that had previously had a budget surplus, low debt and an admired banking regulator. Its deficits and debt were the consequence of the burst property bubble, not the cause.

Europe has barely begun to stabilize its banks. It may take a year or more to create a euro-wide supervisor and reconcile its functions with those of non-euro countries, particularly Britain. Supervision should be far-reaching. The troubles of Spains cajas and Germanys Landesbanken show that small banks can pose as much of a systemic threat as big cross-border ones. The mutualisation of risk may have to encompass a euro-zone bank-resolution fund as well as a joint

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deposit-insurance scheme. Even if paid for initially by the banks, these may need to be backed by taxpayers, notwithstanding German qualms.

The European effect on GDP

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The Never-Ending crisis

IN THE autumn of 2008, the banking sector collapsed with remarkable rapidity. It seemed that every weekend something remarkable happened, from the demise of Lehman Brothers, through the sale of Merrill Lynch to Bank of America, the rescue of AIG and so on. In contrast, the euro zone crisis has unfolded in slow motion so we all feel a bit battle-weary, like First World War soldiers; if we date the problem to the start of 2010, then we are two-and-a-half years in, somewhere between the Somme and Passchendaele. There is the same feeling that those in charge don't know what they are doing; that all this sacrifice is going to waste. To quote Churchill, Europe's leaders seem

decided only to be undecided, resolved to be irresolute, adamant for drift, solid for fluidity, allpowerful to be impotent

A year or two ago, the EU leaders seemed to be operating on the theory that, if Greece could just be propped up, Italy and Spain would have the time to address the problem. Instead, the problems have spread. As Capital Economics writes today

a bailout of the Spanish sovereign - which is looking more likely by the day - would significantly deplete the resources of the EFSF/ESM and leave little in the pot to provide further assistance to Portugal and Ireland and, much more crucially, to deal with serious problems in Italy. Investors

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appear to have cottoned on to this fact. Indeed, the yield on 10-year government bonds rose by more in Italy than in Spain on Tuesday. Spain might need a package of 200 billion, Capital reckons, on top of the 100 billion needed for its banks. The markets are forcing the pace as the rise in Spanish bond yields shows.

It has been tempting, on many occasions, to feel that the end game must be in sight - say, around the time of the proposed Greek referendum or the second Greek election. The temptation is strong now with the Der Spiegel report that the IMF will no longer finance Greece. One possibility is that the Greek exit will act as the Lehman moment, causing such chaos in the markets that the Germans will be forced to rescue Spain, as Hank Paulson was forced to rescue AIG. Or the ECB will step in, promising to cap Spanish and Italian bond yields. The more cataclysmic alternative is that the authorities will fail to act; that the Germans will fear, as Moody's suggested yesterday, that footing the bill for the rest of the euro zone will strain their balance sheet too far. Equity markets are reacting badly at the moment, although not so badly that they are discounting the cataclysmic outcome. Indeed, they have enough to worry about, what with disappointing economic data and weak second quarter results. Perhaps it will take a really bad day - a 10% fall in the Dax not a 2% one - to force action, just as Congress was frightened into approving the Tarp in 2008 by the market collapse after its initial rejection.

All of these developments are now visible in the euro zone, particularly in its peripheral countries. Risk premiums started rising above benign levels in 2009 and then more strongly in 2011-12, while capital flight became rampant in 2011.

But if one considers what might underlie capital movements of this sort, suspicion must also fall on unsustainable policies that extend to countries well outside the euro zone. In the wider
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European Union, countries like Britain or Hungary are as much afflicted by structural deficiencies as some peripheral euro-zone countries are. Exchange-rate flexibility has not helped them much, or at least they have chosen not to exploit it.

Moreover, there are countries with government-debt burdens that are as large, if not larger, than those on Europe's periphery, with the United States and Japan being prime examples. Other countries, like Norway and Switzerland, are running current-account surpluses that exceed 10 percent of their gross domestic product, but are resisting currency revaluation.

It is worth remembering that, for the decade until 2005, Germany was labeled the "sick man of Europe." Germany was uncompetitive when it entered the euro zone, owing to excessive wage and price increases following the country's reunification, a problem that has since been overcome by structural reforms that the country undertook within the single currency. The same is true for the most recent euro-zone member, Estonia, whose rigorous wage restraint ensured competitiveness in the single market in a short period of time.

Why, then, is there such strong doubt that the euro can survive? Some say that the current efforts to enforce sound policies in the peripheral countries are bound to fail and that sacrificing democracy in these countries to keep the monetary union intact is too high a price to pay.

In fact, the efforts of governments and international institutions point the way toward more sustainable solutions. Who would have believed at this time last year that the fiscal pact adopted in March would have been possible? Despite fluctuations, has there not been a considerable reduction in risk premiums for problem countries, without adding to the financing costs of donor countries?

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Much remains unknown. Are we seeing tentative signs of escape from the euro zone's malaise? Will debtor countries be able to stick to tough reform programs, or will their citizens reject austerity? Will donor countries avoid the sort of populist backlash at home that might push them in a protectionist direction?

Intelligent cooperation that avoids moral hazard should be able to prevent panic, reduce risk premiums and permit fuller use of resources. For example, transnational migration flows should certainly be made easier and more attractive. High levels of unemployment, particularly among young skilled workers, could be avoided if donor countries that need migrants to invigorate their own workforces were able to attract them.

More immigration would strengthen skills and raise income levels, while reducing distressed countries' expenditure on unemployment benefits. Greater labor mobility within the EU would also help to create a more open European mindset and weaken old nationalist prejudices.

So, will Europe commit to moving toward political union and thereby address what has remained missing, despite the single market, the euro and the Schengen Agreement's elimination of internal borders?

Five Reasons the Euro Zone Crisis Is Getting Even Worse:

1. Moodys is downgrading everyone. Proving that Germany is no longer immune to the woes of other euro zone countries, Moodys Investors Service downgraded its economic outlook to negative. Luxembourg and the
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Netherlands also had their economic outlook downgraded, as did that of the European Financial Stability Facility, the rescue fund European leaders have created to bailout countries with troubled economies and to (theoretically, as it quite seems now) keep the crisis from spreading.

Only Finland is retaining its AAA rating.

2. The UK is in a double-dip recession. The Diamond Jubilee, to mark Queen Elizabeths 60 year-reign, meant an extra bank holiday, meaning that many offices and factories were closed for two days in June (the 5th and 6th), with some even taking the whole week off. Bad weather in Britain lowering jobs in the service sector and limiting construction work has also pushed the economy back into a recession into the last quarter.

The UK last suffered a double-dip recession in 1975, when Margaret Thatcher became the leader of the Conservative Party. Britains gross domestic product has fallen by a larger than projected 0.7 percent. All told, the UK economy is now 0.8 percent smaller than it was a year ago. 3. Chinas seemingly unstoppable economic growth is declining. The deepening economic crisis in Europe poses a key risk to China, the International Monetary Fund (IMF) says, along with risks within Chinas own borders including a worse than expected decline in the real estate market. Chinas economic growth slowed to a three-year low in the second quarter. Euro zone countries are key export partners for Chinese companies and lessened demand is showing its effects.
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4. Greece isnt meeting the terms of its bailout deal, its economy is contracting, etc.

An assessment this week by the troika (the IMF, the European Central Bank, the European Commission) of Greeces economic situation has found that the country has failed to carry out the debt reduction plan agreed to earlier this year. So Greeces debt burden is only increasing in relation to its gross domestic product.

Moreover, the Greek economy is contracting by 7 percent this year, more than the projected 5 percent and JP Morgan is setting up contingency plans to limit disruptions to its clients should any nation (i.e., Greece) leave the euro zone. 5. Its looking more and more as if Spain will need a full bailout. The interest rate on Spains 10-year debt has risen to 7.56 percent, a new record indicating that before too soon, it could cost too much for Spain to borrow funds.

Spain, whose economy is the fourth-largest in the euro zone, may need 300 billion bailout funds. It has been seeking to avoid the full-blown bailout that Greece, Ireland and Portugal have had to ask for, but many analysts thing this is inevitable as unemployment nears 25 percent and the list of semi-autonomous regions seeking financial assistance from the Spanish central government grows.

The euro, the dream of many a politician in the years following World War II, was established in Maastricht by the European Union (EU) in 1992.

To join the currency, member states had to qualify by meeting the terms of the treaty in terms of budget deficits, inflation, interest rates and other monetary requirements.
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Of EU members at the time, the UK, Sweden and Denmark declined to join the currency.

Since then, there have been many twists and turns for the countries that use the single currency.

History of some very important events:

1999
On 1 January, the currency officially comes into existence.

2001
Greece joins the euro.

2002
On 1 January, notes and coins are introduced.

2008
Malta and Cyprus join the euro, following Slovenia the previous year.

In December, EU leaders agree on a 200bn-euro stimulus plan to help boost European growth following the global financial crisis.

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2009
Slovakia joins the euro.

Estonia, Denmark, Latvia and Lithuania join the Exchange Rate Mechanism to bring their currencies and monetary policy into line with the euro in preparation for joining.

In April, the EU orders France, Spain, the Irish Republic and Greece to reduce their budget deficits - the difference between their spending and tax receipts.

In October, amid much anger towards the previous government over corruption and spending, George Papandreou's Socialists win an emphatic snap general election victory in Greece.

In November, concerns about some EU member states' debts start to grow following the Dubai sovereign debt crisis.

In December, Greece admits that its debts have reached 300bn euros - the highest in modern history.

Greece is burdened with debt amounting to 113% of GDP - nearly double the eurozone limit of 60%. Ratings agencies start to downgrade Greek bank and government debt.

Mr Papandreou insists that his country is "not about to default on its debts".

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2010
In January, an EU report condemns "severe irregularities" in Greek accounting procedures. Greece's budget deficit in 2009 is revised upwards to 12.7%, from 3.7%, and more than four times the maximum allowed by EU rules.

The European Central Bank dismisses speculation that Greece will have to leave the EU.

In February, Greece unveils a series of austerity measures aimed at curbing the deficit.

Concern starts to build about all the heavily indebted countries in Europe - Portugal, Ireland, Greece and Spain.

On 11 February, the EU promises to act over Greek debts and tells Greece to make further spending cuts. The austerity plans spark strikes and riots in the streets.

In March, Mr. Papandreou continues to insist that no bailout is needed. The euro continues to fall against the dollar and the pound.

The eurozone and IMF agree a safety net of 22bn euros to help Greece - but no loans.

In April, following worsening financial markets and more protests, eurozone countries agree to provide up to 30bn euros in emergency loans.

Greek borrowing costs reach yet further record highs. The EU announces that the Greek deficit is even worse than thought after reviewing its accounts - 13.6% of GDP, not 12.7%.

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Finally, on 2 May, the eurozone members and the IMF agree a 110bn-euro bailout package to rescue Greece.

The euro continues to fall and other EU member state debt starts to come under scrutiny, starting with the Republic of Ireland.

In November, the EU and IMF agree to a bailout package to the Irish Republic totaling 85bn euros. The Irish Republic soon passes the toughest budget in the country's history.

Amid growing speculation, the EU denies that Portugal will be next for a bailout.

2011
On 1 January, Estonia joins the euro, taking the number of countries with the single currency to 17.

In February, eurozone finance ministers set up a permanent bailout fund, called the European Stability Mechanism, worth about 500bn euros.

In April, Portugal admits it cannot deal with its finances itself and asks the EU for help.

In May, the eurozone and the IMF approve a 78bn-euro bailout for Portugal.

In June, eurozone ministers say Greece must impose new austerity measures before it gets the next tranche of its loan, without which the country will probably default on its enormous debts.

Talk abounds that Greece will be forced to become the first country to leave the eurozone.

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In July, the Greek parliament votes in favour of a fresh round of drastic austerity measures, the EU approves the latest tranche of the Greek loan, worth 12bn euros.

A second bailout for Greece is agreed. The eurozone agrees a comprehensive 109bn-euro ($155bn; 96.3bn) package designed to resolve the Greek crisis and prevent contagion among other European economies.

In August, European Commission President Jose Manuel Barroso warns that the sovereign debt crisis is spreading beyond the periphery of the eurozone.

The yields on government bonds from Spain and Italy rise sharply - and Germany's falls to record lows - as investors demand huge returns to borrow.

On 7 August, the European Central Bank says it will buy Italian and Spanish government bonds to try to bring down their borrowing costs, as concern grows that the debt crisis may spread to the larger economies of Italy and Spain.

The G7 group of countries also says it is "determined to react in a co-ordinate manner," in an attempt to reassure investors in the wake of massive falls on global stock markets.

During September, Spain passes a constitutional amendment to add in a "golden rule," keeping future budget deficits to a strict limit.

Italy passes a 50bn-euro austerity budget to balance the budget by 2013 after weeks of haggling in parliament. There is fierce public opposition to the measures - and several key measures were watered down.

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The European Commission predicts that economic growth in the eurozone will come "to a virtual standstill" in the second half of 2011, growing just 0.2% and putting more pressure on countries' budgets.

Greek Finance Minister Evangelos Venizelos says his country has been "blackmailed and humiliated" and a "scapegoat" for the EU's incompetence.

On 19 September, Greece holds "productive and substantive" talks with its international supporters, the European Central Bank, European Commission and IMF.

The following day, Italy has its debt rating cut by Standard & Poor's, to A from A+. Italy says the move was influenced by "political considerations".

That same day, in its World Economic Outlook, the IMF cuts growth forecasts and warns that countries are entering a 'dangerous new phase'.

The gloomy mood continues on 22 September, with data showing that growth in the eurozone's private sector shrank for the first time in two years.

The sense of urgency is heightened on 23 October, when IMF head Christine Lagarde urges countries to "act now and act together" to keep the path to economic recovery on track.

On the same day, UK Prime Minister David Cameron calls for swift action on the debt crisis.

The next day US Treasury Secretary Timothy Geithner tells Europe to create a "firewall" around its problems to stop the crisis spreading.

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A meeting of finance ministers and central bankers in Washington on 24 September leads to more calls for urgent action, but a lack of concrete proposals sparks further falls in share markets.

After days of intense speculation that Greece will fail to meet its budget cut targets, there are signs of a eurozone rescue plan emerging to write down Greek debt and increase the size of the bloc's bailout fund.

But when, on 28 September, European Union head Jose Manuel Barroso warns that the EU "faces its greatest challenge", there is a widespread view that the latest efforts to thrash out a deal have failed.

The sense that events are spinning out of control are underlined by Foreign Secretary William Hague, who calls the euro a "burning building with no exits".

On 4 October, Euro zone finance ministers delay a decision on giving Greece its next installment of bailout cash, sending European shares down sharply.

Speculation intensifies that European leaders are working on plans to recapitalize the banking system.

On 6 October the Bank of England injects a further 75bn into the UK economy through quantitative easing, while the European Central Bank unveils emergency loans measures to help banks.

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Financial markets are bolstered by news on 8 October that the leaders of Germany and France have reached an accord on measures to help resolve the debt crisis. But without publication of any details, nervousness remains.

Relief in the markets that the authorities will help the banking sector grows on 10 October, when struggling Franco-Belgian bank Dexia receives a huge bailout.

On 10 October, an EU summit on the debt crisis is delayed by a week so that ministers can finalize plans that would allow Greece its next bailout money and bolster debt-laden banks.

On 14 October G20 finance ministers meet in Paris to continue efforts to find a solution to the debt crisis in the eurozone.

On 21 October eurozone finance ministers approve the next, 8bn euro ($11bn; 7bn), tranche of Greek bailout loans, potentially saving the country from default.

On 26 October European leaders reach a "three-pronged" agreement described as vital to solve the region's huge debt crisis.

After marathon talks in Brussels, the leaders say some private banks holding Greek debt have accepted a loss of 50%. Banks must also raise more capital to protect them against losses resulting from any future government defaults.

On 9 December, after another round of talks in Brussels going through much of the night, French President Nicolas Sarkozy announces that eurozone countries and others will press ahead with an inter-governmental treaty enshrining new budgetary rules to tackle the crisis.

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Attempts to get all 27 EU countries to agree to treaty changes fail due to the objections of the UK and Hungary. The new accord is to be agreed by March 2012, Mr. Sarkozy says.

2012
On 13 January, credit rating agency Standard & Poor's downgrades France and eight other eurozone countries, blaming the failure of eurozone leaders to deal with the debt crisis.

Three days later, the agency also downgrades the EU bailout fund, the European Financial Stability Facility.

Also on 13 January, talks between Greece and its private creditors over a debt write-off deal stall. The deal is necessary if Greece is to receive the bailout funds it needs to repay billions of euros of debt in March. The talks resume on 18 January.

The "fiscal pact" agreed by the EU in December is signed at the end of January. The UK abstains, as does the Czech Republic, but the other 25 members sign up to new rules that make it harder to break budget deficits.

Weeks of negotiations ensue between Greece, private lenders and the "troika" of the European Commission, the European Central Bank and the IMF, as Greece tries to get a debt write-off and make even more spending cuts to get its second bailout.

On 10 February, Greece's coalition government finally agrees to pass the demands made of it by international lenders. This leads to a new round of protests.

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But the eurozone effectively casts doubt on the Greeks' figures, saying Athens must find a further 325m euros in budget cuts to get the aid.

On 12 February, Greece passes the unpopular austerity bill in parliament - two months before a general election.

Coalition parties expelled more than 40 deputies for failing to back the bill.

On February 22, a Market survey reports that the eurozone service sector has shrunk unexpectedly, raising fears of a recession.

The next day the European Commission predicts that the eurozone economy will contract by 0.3% in 2012.

March begins with the news that the eurozone jobless rate has hit a new high.

However, the economic news takes a turn for the better just days later with official figures showing that the euro zones retail sales increased unexpectedly in January by 0.3%, and the OECD reports its view that the region is showing tentative signs of recovery.

On 13 March, the eurozone finally backs a second Greek bailout of 130bn euros. IMF backing was also required and was later given.

The month ends with a call from the OECD for the eurozone rescue fund to be doubled to 1tn euros. The German chancellor, Angela Merkel says she would favour only a temporary boost to its firepower.

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On 12 April, Italian borrowing costs increase in a sign of fresh concerns among investors about the country's ability to reduce its high levels of debt.

In an auction of three-year bonds, Italy pays an interest rate of 3.89%, up from 2.76% in a sale of similar bonds the previous month.

Attention shifted to Spain the next day, with shares hit by worries over the country's economy and the Spanish government's 10-year cost of borrowing rose back towards 6% - a sign of fear over the country's creditworthiness.

On 18 April, the Italian government cut its growth forecast for the economy in 2012. It was previously predicting that the economy would shrink by 0.4%, but is now forecasting a 1.2% contraction.

On 19 April, there was some relief for Spain after it saw strong demand at an auction of its debt, even though some borrowing costs rose.

The 10-year bonds were sold at a yield of 5.743%, up from 5.403% when the bonds were last sold in February.

On 6 May, a majority of Greeks vote in a general election for parties that reject the country's bailout agreement with the EU and International Monetary Fund.

On 16 May, Greece announces new elections for 17 June after attempts to form a coalition government fail.

On 25 May, Spain's fourth largest bank, Bankia, says it has asked the government for a bailout worth 19bn euros ($24bn; 15bn).
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On 9 June, after emergency talks Spain's Economy Minister Luis de Guindos says that the country will shortly make a formal request for up to 100bn euros ($125bn; 80bn) in loans from eurozone funds to try to help shore up its banks.

On 12 June, optimism over the bank bailout evaporates as Spain's borrowing costs rise to the highest rate since the launch of the euro in 1999.

On 15 June, former UK chancellor of the exchequer Gordon Brown underlined fears of contagion with a warning that France and Italy may need a bailbout.g

On 17 June, Greeks went to the polls, with the pro-austerity party New Democracy getting most votes., allaying fears the country was about to leave the eurozone.

Downgrading Frances Credit Rating:

On Jan. 13, 2012, Standard & Poors stripped France of its sterling credit rating, downgrading it one notch from AAA to AA+. The ratings agency also cut Portugals credit to junk status and downgraded Italys debt by two steps in a wide-ranging revision of European countries caught in
the crisis.

The actions, which lowered the ratings of nine countries, would be the strongest signal yet that Europes sovereign debt woes were far from over and would pose fresh political challenges for politicians as they try to stabilize the problem on the Continent. A downgrade by a single ratings agency like Standard & Poors could have an immediate, though not devastating, impact on the

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countries ability to borrow money. S.& P. warned in December 2011 that the agency was reviewing the credit ratings of 15 European Union countries because of the crisis.

Germany and the Netherlands, which were on the original list, did not receive a downgrade. In addition to Italy and Portugal, two nations Spain and Cyprus had their ratings cut by two notches. Austria, Malta, Slovenia and Slovakia, along with France, were lowered by one grade. The ratings of the other countries in the review Belgium, Estonia, Ireland and Luxembourg were unchanged. The ratings revisions came at the end of a week in which Mr. Sarkozy and Prime Minister Marioof Italy warned that the crisis could deepen if growth. Both delivered their messages to Chancellor Angela Merkelin her offices in Berlin, prompting the German leader to admit for the first time that the harsh program of austerity she has been pushing on the euro zone was not a cure-all for the crisis

The Debt crisis first surfaced in Greece in October 2009, when the newly elected Socialist government of Prime Minister George A. Papandreou announced that his predecessor had disguised the size of the countrys ballooning deficit.

The pursuit of a single monetary policy for the EU as a whole is making the life of some other smaller countries with lower productivity uncomfortable. In a situation like the one faced by Greece, if Greece had its own currency, it would have devalued but that option is not available now. No doubt, these small countries benefited earlier being under the umbrella of the EU. Given this situation, it may seem incumbent on the richer countries within the EU to come to the help of smaller countries. The question that will be raised is for how long and whether such assistance will be an open-ended one. The euro would perhaps survive as a common currency of the EU.

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But for it to continue as a common currency, several fundamental changes may have to be introduced.

The Greek tragedy has opened our eyes to many things. No one can any longer mock the
critics of high fiscal deficits. Not only was the fiscal deficit of Greece high but that there were attempts to manipulate the numbers to hide the reality. It took a long time before this could be uncovered. It is now estimated that the budget deficit of Greece is in the range of 13.5 per cent of GDP. The stock of debt is equivalent to 115 per cent of GDP. Greece has reached a critical point where it cannot meet its repayment obligations without outside help. The eurozone and the IMF have put together an ambitious package to help Greece. It is not known at this stage how this will be implemented. The package of support will also require Greece to put through a series of austerity measures. Unfortunately, there is a strong resistance to such measures.

The debt problem of Greece is compounded by the fact that a good part of the government debt is held by foreign institutions, particularly foreign banks. It is estimated that 106 billion of government bonds may be held by foreign banks. A default by Greece will have serious consequences for its economy. It will dry up all sources of external funding which will then weaken the economy even more. Greece is also having to deal with a huge debt problem when it is hardly growing.

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Hope for a Silver Lining.

WHEN history books trace the evolution of the euro crisis, September 2012 will mark the beginning of a new chapter. Recent days have seen decisive moves from Europes notoriously incremental policymaking machinery. On September 12th Germanys constitutional court backed the European Stability Mechanism (ESM), the euro zones permanent rescue fund, removing the last big hurdle to its launch. The same day, the European Commission laid out a blueprint for joint European banking supervision, the first step to a banking union. Days earlier the European Central Bank (ECB) announced that, under certain conditions, it would buy unlimited amounts of the bonds of troubled euro-zone countries.

Taken together, these actions mark a big change. At best, they constitute the foundations of a more sustainable monetary union. The euro zone now has a plan for bank supervision. It will be haggled over and watered-down, but the record of European diplomacy suggests that once
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proposals exist, something, eventually, tends to be agreed on (see article). Most important, the euro zone now has a central bank committed to being a lender of last resort. Yes, the commitment is conditional on countries securing help from, and adhering to, a rescue plan. But the ECB has made clear, for the first time, that it is willing to intervene without limit if need be.

The hope is that this marks the beginning of the end of the euro crisis. In the best possible outcome, the ECBs pledge, by itself, will push euro-zone debt markets into a positive cycle one where yields on sovereign debt in peripheral economies fall as investors lower the probability of the euros collapse, and as yields fall those countries debt dynamics and economic prospects improve. Bond yields in Italy and Spain have already plunged in recent weeks, in anticipation of the ECBs action, as investors have become leery of betting against the central bank. Spains Prime Minister, Mariano Rajoy, hopes to avoid even asking for a rescue package. Given the state of Spains banks, and the weakness of its economy and public finances, that seems implausible. But even if Spain (and later Italy) is forced to enter a rescue plan, there is now a clear sense of what that would imply, and that certainty gives optimists a second reason for confidence.

The ESM would help fund any new government borrowing, while the ECB would buy bonds in the secondary market. Both routes would keep a cap on bond yields. And both vehicles would be a backdoor route to a limited form of debt mutualisationanother necessary condition for the euro zones future. Euro-zone countries are jointly liable both for the rescue funds and the central banks balance-sheet. It may be less elegant than Alexander Hamiltons plan for assuming the states debts in America in 1789, but some think the ingredients of a solution to the euro-zone debt crisis are now in place.
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This newspaper would be delighted if that turned out to be the case. We have long argued that the single currency needs a lender of last resort, a banking union and limited debt mutualisation. Given the costs of break-up, evidence of progress towards resolving the crisis, however inelegant, is to be cheered.

CONCLUSION:

Possible Outcomes Of Euro Crisis:

Treaties are like roses and young girls. They last while they lastCharles de Gaulle Why not leave anyway? Different possible scenarios If Greece left the Eurozone, it could: Reintroduce a national currency, regain control of its monetary and exchange rate policies, and Devalue, to restore competitiveness Or Germany (perhaps with some likeminded northern European countries) could: Introduce a new Euro or Northern Euro The neuro would appreciate against the Euro, helping to restore Eurozone competitiveness (for the PIIGS)

Scenario 1: Monetary expansion:

ECB is given the go ahead to inject significant liquidity into vulnerable economies and banks. Recession is avoided, interest rates are kept low in the short term, but inflation rises well above its 2% target, while the euro depreciates.

Scenario 2: Orderly defaults

A programme of voluntary defaults is agreed for the most indebted countries, which triggers a contractionary debt spiral and a prolonged recession, lasting between 2 and 3 years, and which results in a cumulative loss in GDP of around 5%.
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Scenario 3: Greek exit

Greece is compelled to leave the Eurozone, and then suffers a sharp deterioration in its economy, a rapid depreciation of its new currency and an inflation spike. The Eurozone seeks to protect its currency through tough fiscal discipline and other investor confidence increasing measures, but still suffers a recession that lasts for up to two years.

Scenario 4: New currency bloc

A Franco-German acknowledgement that the existing Euro zone is unsustainable paves the way for a new, smaller and more tightly regulated currency bloc. We expect the new euro to appreciate dramatically and for the new bloc to benefit from a boom in domestic demand. Economies that are excluded suffer a sharp currency depreciation and severe economic contraction.

We expect these scenarios to have an impact well beyond the Euro zone; countries like the UK and US are likely to see falls in exports and banking sector problems but possibly also increased levels of capital inflows, as investors look to place a larger proportion of their portfolios in safe haven markets. Other countries, like China, will have to deal with a decline in a significant proportion of their export markets.

BIBLIOGRAPHY:
www.pwc.ocom www.bbc.co.uk www.economist.com www.forbes.com www.europeandsis.org www.themoscowtimes.com
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