Questions And Answers About Europe's Debt Crisis

Published November 30, 2011 11:54AM (EST)

WASHINGTON (AP) — European finance officials who met Tuesday in Brussels were trying to save their common currency and prevent a meltdown that could tip the global economy into recession. The debt crisis that began in Greece is threatening to overwhelm much bigger economies in Spain, Italy and even France.

The finance ministers made little progress. Major disputes will now have to be addressed by European leaders, who will hold their own meeting in Brussels next week.

Markets had rallied this week on hopes that the 17 countries that use the euro would reach a deal and defuse the panic. But on Wednesday, world stocks fell after the finance officials' meeting failed to stem fears that the eurozone might be nearing a breakup.

Here are some questions and answers about the crisis:

Q: Why the urgency now?

A: Earlier efforts, like bailouts of Greece, Portugal and Ireland, haven't convinced investors that European policymakers can or will resolve the crisis. Jittery investors are demanding that European governments pay ever-higher interest rates on their bonds. Yields on Italian bonds, for instance, top 7 percent. That's considered unsustainable. Even Germany, Europe's economic powerhouse, struggled to sell bonds last week.

Q: Why are higher interest rates such a problem?

A: They make it harder for governments to pay debts. And they slow growth. Tax revenue then falls. The cost of unemployment benefits and other social programs rise. Some countries might abandon the euro, plunging the continent and perhaps the world's economy into recession.

Q: Why would countries want to jettison the euro and go back to their own currencies?

A: To become more economically nimble. When they joined together 12 years ago, the 17 eurozone countries surrendered control of their interest-rate policies to a new European Central Bank. That meant they couldn't cut rates to boost their economies. Nor could they reduce the value of their currencies, to give their exporters an edge. (A lower currency makes exports cheaper for foreigners to buy.) Abandoning the euro would let them escape an economic trap.

Q: How did Europe get into this mess?

A: The euro made it easier to do business across Europe and made the continent a potent economic bloc. Yet the experiment was flawed. Countries were harnessed to one another despite different economies and cultures but still managed their own finances. As long as prosperity reigned, banks were happy to lend at low rates even to weaker countries like Greece. The euro meant lenders didn't have to worry about inflation in individual countries. Greece and others exploited the opening by borrowing heavily to finance their swelling budgets. But once the Great Recession hit hard, their debt proved crushing.

Q: Why is a solution so hard?

A: The ECB and Germany have resisted aggressive action. Many economists want the central bank to buy the debt of Italy and other struggling countries. That would push down interest rates and ease those countries' borrowing costs. The ECB has bought Italian and Spanish bonds. But it's loath to do so in a big way. The ECB says it must control inflation, not be a lender of last resort to governments. Germany opposes one idea — creating joint bonds backed by the whole eurozone — because it fears its own borrowing costs would surge if it had to borrow jointly with weaker countries.

Q: What options have European officials considered?

A: Things that would have been unthinkable just weeks ago. One option would be to have countries cede control of their budgets to a central authority. That authority would stop countries from spending beyond their means. There has also been talk of forming an elite group of euro nations to guarantee each other's loans. It would require fiscal discipline from any country that wants to join.

Q: What would happen if some countries left the eurozone?

A: It could be catastrophic. Depositors would pull money from banks in weak countries that dropped the euro. Savers wouldn't want their euros replaced with feeble national currencies. If countries tried to repay their euro debts with their own currencies, they'd be considered in default. They'd struggle to borrow. So would corporations. Economists at UBS estimate that a weak economy that left the eurozone would shrink 50 percent.

Q: Could a strong country like Germany leave the eurozone to avoid the damage?

A: Not necessarily. Germany's currency would likely shoot up if it did. Its exports would then become costlier for foreigners. UBS says that if Germany left the eurozone, its economy would decline 20 to 25 percent. And the pain would spread. The United States, Asia and others would suffer if worldwide credit froze and European economies sank into recession. U.S. companies have poured $2.2 trillion into long-term investments in Europe like factories and acquisitions. Companies from Whirlpool to Abercrombie & Fitch to General Motors have reported sagging sales in Europe.

Q: Can Europe's leaders solve this mess?

A: Their performance so far doesn't inspire confidence. Some investors are bracing for a crackup of the eurozone, which a few analysts say could happen within days, possibly by the time European leaders end their meeting next week.

Resolving the crisis involves getting up to 17 countries and the ECB to agree on a solution. "This is not just a crisis of Greece or this or that country," says Nicolas Veron, senior fellow at the Brussels-based think tank Bruegel. "It's a crisis of European institutions."

By Salon Staff

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