The seven classes of the Eurozone

2011-08-04

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended. Information may be out of date. For further questions contact me.

The 17 countries of the euro (deep blue) plus the two countries that use the euro (light blue) – Andorra is also one of them but cannot be seen on the map Image Source: Wikipedia

Eurozone countries:

• Germany
• France
• Italy
• Spain
• Netherlands
• Austria
• Belgium
• Finland
• Greece
• Ireland
• Portugal
• Slovakia
• Slovenia
• Luxembourg
• Malta
• Cyprus
• Estonia

The eurozone is falling apart while its leaders seem to be living in wonderland where they cannot possibly realize how their vaunted policies are ruining the euro. Amid this unprecedented crisis, whose contagion to the core has not been prevented, it is useful to look into the seven classes of states that currently comprise the euro area, which will allow us to better understand events as those unfold.

The first of the seven classes in the eurozone is Greece, which currently experiences the most severe shocks from the systemic crisis of the euro. Greece is considered to be a “unique case” by EU officials, since the combination of sovereign debt, budget deficit and lack of competitiveness cannot be found elsewhere. Of course this mode of thinking is utterly false, since once a country enters the downward spiral of the crisis then it cannot do otherwise. All others countries that are endangered can become as “unique” as Greece currently is. Greece is practically insolvent under the current conditions, even with the second bailout that was agreed on the July 21 EU summit, as that will do no good in addressing the fundamentals of the crisis (see my Full Analysis of the outcomes of the EU summit). The new deal is only a way of pretending there is no systemic problem and of postponing the formal default of Greece.

The second class is Ireland and Portugal, who are the other two countries (together with Greece) to receive bailouts from the European Financial Stability Facility (EFSF – the mechanism that was set up ad hoc to bailout countries in need). Ireland and Portugal are currently standing in a better position than Greece, but there is no guarantee that they will remain in that position. Even in the new deal of the EU summit, there are no serious provisions for those two. Markets and analysts expect that they might well come to the need of a second bailout and they too might ask for a re-negotiation of the terms of their loans (a restructuring of their debt). As the crisis continues to spread the scenario that the two countries will come to the need of a second bailout, is reinforced.

The third class is comprised of Italy and Spain, the third and fourth respectively largest economies in the eurozone. I see Italy and Spain as the “new Ireland and Portugal” since the current interest rates on their 10-year bonds are similar to those that existed just before Ireland and Portugal came to the need of the EFSF (of bailouts). Under the current structure of the system if Italy and Spain need bailouts then the euro will collapse. The surplus countries, mainly Germany, will find it unsustainable to bailout its other partners and will simply drop out of the euro.

The fourth class is France and Belgium. Belgian and French interest rate spreads are starting to rise worryingly, while France’s exposure to the European South together with its own issues of competitiveness and sovereign debt, make it possible for the second largest economy of the euro to get into trouble. Both countries were once considered part of the core of the euro, of the surplus countries. Today we see a shift to that role, as those two are heading full spreed away from the core towards the deficit countries. France and Belgium are close behind Italy and Spain. Should France become a peripheral country, then the core of the euro will only be left with one big economy, Germany.

The fifth class is the core of the euro, which is composed of the strong surplus countries of Germany, Austria, the Netherlands and Finland. In the core only Germany is a big economy, the biggest of the euro. These countries are in the best possible position currently, but since Euro countries are like climbers on a cliff tied together, if one falls, all fall together. Under the current conditions and as the system is currently structured, the core countries will find it extremely difficult to keep the euro in tact, if market pressures worsen the position of some of the countries in classes three and four (Italy and Spain ~ France and Belgium).

The sixth class is Cyprus. Cyprus should be placed in the third class, in terms of economic situation, but due to the very small size of its economy I thought it would not be accurate to group it together with Italy and Spain. Cyprus is exposed to Greece and is also facing extremely high borrowing costs from the markets, due to a number of reasons that I explained in a previous article (see Cyprus will soon be caught in the eye of the storm). I personally believe that by the end of this year or by the first months of the next year Cyprus will ask for a bailout. Cyprus has short-term financing needs of around 2 billion euro, which is nothing compared to let’s say the second bailout to Greece (more than 100 billion).

Finally the seventh class is comprised of all the other member-states of the euro that were not mentioned so far. They lie somewhere in between.

Having this classification in mind will allow us to better grasp the dynamics in the ongoing crisis. If things remain as they are, that is if European leaders do not come up with a European solution to the systemic crisis that plagues the eurozone, then the euro will collapse and these classes of states will only remind us how diverging economies cannot form an optimal currency area.

</div>