What’s actually going on in Europe?

Yahoo! Finance editor James Andrews takes you through what’s actually happening in Europe at the moment.

If it’s not Greece, it’s Spain in the headlines. Or Italy. Or France.

A year or so back it was Ireland. But in among all the talk about “bond yields”, “sovereign debt”, “eurobonds” and the like what’s actually happening? Surprisingly enough, it’s not that complicated.

Why are we in this mess?
It’s pretty simple, over the last 10 years interest rates were low and economies grew based on free and easy access to cheap loans. House prices, in particular, soared.

Clever people at investment banks reckoned they had found a way to eliminate the risk of borrowers going broke and not paying back their debts (they hadn’t), so more money was lent to riskier people too.

In Europe, the effects of being in the euro added to this, meaning countries that should have been scrutinised more closely were given a free pass to borrow what they liked for not much cash.

Governments cashed in, using cheap money borrowed from the markets to fund ever-increasing spending and more and more benefits and services in the hope that the economy would keep growing forever and this would mean debts would be paid back without a problem.

Everyone seemingly forgot about the bad times. In fact, one chancellor went as far as to claim we would “never return to the old boom and bust” while in the middle of the biggest boom in decades.

That wasn’t very clever was it?

No, no it wasn’t. Eventually the credit crunch happened, house prices crashed and it all fell apart.

Wasn’t this years ago though? Why is it in the headlines now?

There was a delay. Things were going wrong so often and so fast almost no one thought that far ahead.

First the banks collapsed, then stock markets crashed, then governments stepped in to help banks, then world economies fell apart and countries were left with even more costs (as unemployment rose), less money to pay them and banks less willing to lend them the cash to meet the difference.

But most banks took a long time to realise the endgame here. Countries would have to default on their debts or devalue their currencies (ie print more cash to make their debts worth less) eventually.

Now, no one wants to lend money to someone who they think won’t pay it back – or be paid back in money that’s worth half as much – so lenders demanded higher interest rates. This made everything worse.

Countries already had less money coming in and more going out. And the money they were borrowing to fund the difference was getting more and more expensive making the whole process even worse.

Especially in the eurozone.

[Related feature: How to leave the euro]

Why the eurozone?

Put simply, a lot of countries were hiding behind Germany for a long time. This let the problems get far bigger before they were even acknowledged, let alone dealt with.

Being in the euro meant places like Greece, Ireland, Spain, Portugal, Italy and even France (to an extent) kept getting cheap loans to pay for services, benefits, to support the banks and keep taxes low because people were sure that the stronger countries in Europe would support them.

No one wants to vote for a government that says “you’ll pay more tax and get less back” so politicians have been making like ostriches for a fair few years. Many of them actually believing there just wasn’t a problem.

This is now coming back to hit them hard. Massive unemployment (especially among the young), riots and street fights when governments try to make ever-bigger cuts. Portugal has even cancelled a series of holidays.

The only country making a concerted effort to slash spending to what’s seen as a sustainable level is Ireland. That’s why it’s been mostly out of the headlines for the last year.

But it isn’t a pleasant process, and it’s understandable why voters are rejecting it and politicians looking for any other way out they can.

The constant back and forth, headlines, summits, governments collapsing, new elections, bailouts etc are about how they plan to fix this. With the attention shifting from Greece to Spain to Italy as people propose solutions for one problem, get scared by another, then realise the first solution wasn’t good enough and so on.

So far no one’s been willing to just step up and do something big enough to deal with the problem (as Iceland was eventually forced to do a few years back).

So in a nutshell then?

A bunch of countries in Europe are spending way more than they get back in tax and the people lending them the cash to make up the difference are demanding higher and higher interest rates.

The problem is made worse because they can’t just print more money to pay people back, because they don’t control their currencies.

So either they need to leave the euro and be in a worse position than they are now, but be able to deal with it themselves, or every country that uses the euro needs to act together and make it a bit worse for everyone – something countries that didn’t massively overspend don’t think is fair.

What we’re watching now is people arguing over which one will happen and how.

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