The severed Roots that caused the Drastic collapse of the Eurozone Economy

The eurozone economy, reputed to be one of the strongest for years now, seems to have collapsed in the worst way possible, recording a contraction of 12.1% of GDP in the second quarter. While high rates of growth are expected for the 3rd quarter, they will not be nearly large enough to even make up for the damage of H1. From there on out, the recovery is predicted to be gradual. Although, as we see the negative impacts hitting each country unevenly with Germany, Spain, France, and such large economies being hit tremendously worse as compared to eastern countries such as Latvia and the Czech Republic, its recovery is expected to be of the same nature. Rosie Colthorpe from Oxford Economics analyses that Eurozone GDP may only regain its high level of the 4th quarter of 2019 by mid-2022. But, could it be that the fall of this economy had a rather deep rooted underlying cause that allowed for the pandemic to break its crumbling foundation so severely?

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The global financial crisis of ’07-’08 had left the world in a fix, and governments rushing to do all that they can to pull countries out of the mess. During that time, a total of 114 European banks had received governmental support, also allowing them to carry non-performing loans and assets on their individual balance sheets. This created a multilayered European banking sector that included not only the assets that were held “mark to market,” but also assets that had lost value, and assets that were nearly or totally worthless. Instead of writing them off and recapitalising, bank balance sheets carried defaulted loans, and worthless assets were written based on their nominal value, or purchase price. In practice, bank’s were fabricating their balance sheets. If we were to look at this in a more traditionally accounted perspective, the European banking sector may just be in an insolvent state for the past decade now. When Greece approached another major fall in 2011, the Eurozone began to issue bilateral loans and established the ESM, which issued bonds to finance the ailing governments. This step was essentially a breach of article 125 of the TFEU which forbade mutual fiscal responsibility. That year, The European central bank also launched an outright monetary transactions program in order to stabilise the sovereign bond makers of weaker countries. This program increased the value of the government bonds they were holding, and sustained the weaker banks. In turn, these banks began to lend money to what are known as “Zombie” corporations, which are those that depend on bailouts in order to operate. However, this created a rather adverse affect on the European economy because these firms chose to ineffectively utilise these loans, leaving creditworthy firms to suffer from the misallocation of credit. In hindsight, had leaders chosen to let Greece fall to its knees during their banking crisis itself, the recession resulted would have ended soon enough, banks would recapitalise, the sector as a whole would be able to be built back up again with a stronger base. However, the clean up job and actions taken to immediately form short run benefits at the time, were so poor that it created numerous economic and political loopholes, and looked over the long-run issue that they could potentially be faced with. The corona virus pandemic called for several heavy handed measures, which just hastened and magnified the eventual plunge of the eurozone economy.

In present time, we know that the service sector has taken the brunt of the impact as hotels, restaurants, and the entire tourism industry is under colossal turmoil. While service sector jobs were cut at the steepest rate ever witnessed, manufacturing payrolls have had the sharpest drop since April of 2009. Last month, EU leaders procured a landmark stimulus package in order to rescue their economies from the devastation of this pandemic, with a 750 billion euro ($875 billion) agreement. In light of this package, we will see countries raising funds through collectively selling bonds, for those hit worst by the pandemic in the form of grants. Additionally, the bloc budgeted a whopping 1.1 trillion euros to finance the existing European Union polices for agriculture, migration and other such programs. These groundbreaking measures are necessary in order to ensure the union’s stability and opulence. With this, leaders hope to be able to reverse the recession at least by the next year in order to have a faster recovery in 2022 and onwards. However since the very beginning, the union has always had concerns in its capabilities of maintaining nation-state sovereignty and developing joint federal-style structures. They are currently facing hostility from wealthier northern countries like the Netherlands and Austria that fear debt mutualisation would diminish their own credit ratings, and simultaneously allow the weaker southern countries to free-ride and avoid making reforms to their own systems. Regarding this concern specifically, the bloc would effectively be carrying out a solution quite similar in its potential results, to what was done in the previous two performed bailouts.

The downfall of one of the most impenetrable economies at face value seems to be due to the same reason that has locked the rest of the world. Only diving deeper into the depths of its history, do we begin to see that the ferociousness of and velocity at which the eurozone plummeted was welcomed years ago. That is, by the teetering foundation of the bloc, when they chose to wrongly recover their previous crises in 2008 and 2011. The historic collapse of the eurozone economy is something the European Union and the rest of the world must learn from, or the building blocks of today’s faulty Covid reconstruction will result in tomorrow’s unknown crumble to be even more catastrophic.