The European Union's Dead Weight

By Jonas Elmerraji | March 08, 2010 AAA
The European Union's Dead Weight

As leaders in the European Union (EU) struggle to reach some sort of agreement over a bailout for Greece, some investors have been left wondering whether the EU's economic structure makes sense. After all, given the incredibly diverse nature of the EU's member states, is it possible for less prosperous countries to share an economic system with some of the largest powers in the world? Here's a look at the fallout from the Greek debt debacle.

What Is the EU?
The EU is an economic and political union that's made up of 27 European member states. The EU collectively represents member states politically through its political apparatus, but politics have taken a back seat to the organization's economic role in 2010. Earlier this year, investor anxiety swelled over the level of debt carried by Greece – as well as the country's ability to meet its financial obligations. Credit ratings agencies have slashed the countries sovereign debt as a result.

Now, with Greek officials having to assuage fears on a month-to-month basis, the country is turning to bigger EU powers, like Germany and France, for assistance. To be fair, Greece isn't alone in its financial woes. Investors are keeping a watchful eye on all of the "PIIGS" economies right now – that is, the economies of Portugal, Italy, Ireland, Greece, and Spain. (Find out how these worldly offerings can spice up your portfolio, in Go International With Foreign Index Funds.)

PIIGS in a Blanket
Each of those five countries is carrying significant debt loads and deficits as a percentage of GDP. That's a problem for the EU, particularly given the fact that the Stability and Growth Pact, one of the EU's governing agreements, disallows countries from carrying sovereign debt in excess of 60% of GDP or a deficit in excess of 3% of GDP. Despite these mandates, Greece, for example, is expected to carry a 125% gross debt relative to its gross domestic product through 2010, while Spain has an 84.6% ratio.

Spain currently has an unemployment rate that is nearing 20%, while other countries such as Italy are finding themselves of verge being overwhelmed with debt as well. Concerns have even emerged about the United Kingdom who is likewise facing tough economic conditions. Many analysts view Germany and France as the only truly stable countries within the EU.

Debt Repayment
On an absolute level, Greece's $270 billion debt load pales in comparison to the $700 billion U.S. bank bailouts – by a factor of more than two – but it's the systemic problems that have people worried. Currently, Greece is paying 2% more in interest than the Germans pay on its debt. To minimize the risk of additional financial problems, EU member states are hoping to neutralize the fallout from Greece's straits, but that bailout cash won't come without harsh stipulations. (Should The U.S. Switch To A Flat Tax? Some countries have begun charging a flat tax rate instead of the gradual tax system of the Western world.)

Strings attached to bailout funds include stringent reforms to cut back the country's deficit immediately, and it seems unlikely that the Germans and French will agree to shell out any of their euros without them.So, will fast action save the system, or are economic inequities going to pose serious economic problems in the future?

PIIGS Flying
It's important to remember that the PIIGS countries aren't the poorest countries in the EU – far from it. In fact, all five nations are among the 15 largest EU member economies, making up a substantial portion of the EU's total GDP. And four of the five have per capita GDPs that are higher than the EU average.

Just as Americans spent their way into a serious financial disaster in the years leading up to 2008's meltdown, the PIIGS countries were busy undertaking colossal government spending and making risky investments. Ultimately, the key to shoring up European nations' economies is going to be reigning in crippling deficits and limiting government outlays.

The Bottom Line
With economic fundamentals recovering in Europe, it's likely that fast action on the part of the European Union will stave off a serious crisis in Greece. A shared currency and interwoven economies ensure that the EU's member countries share each other's fates as we roll into 2010. Currently, there is much speculation about the fate of the European Union and the euro; while breaking news seems to be making the headlines on a day by day basis, the one thing that remains certain is that Greece and the other troubled nations are in need of financial reform.

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