Monday 30 January 2012

Why the European Sovereign Debt Crisis is Bad

Good morning and happy Monday to everyone!

This morning I'd like to talk about the European Sovereign Debt Crisis. You may have heard about this from your local newsman. If you're from North America you may be confused as to why you would care.  Well, give me a few moments and I'll give you the nutshell version for 6 year olds.


Imagine you know a man, let's call him Costa.  Costa is Greek, and just happens to be the type of person who should never have a credit card. Costa, you see, is a shop-a-holic.  He likes to keep up appearances, so he buys the same house, car and small kitchen appliances as his neighbours, Hans the German and Jacques the Frenchman. The only problem is, Costa doesn't make as much as they do.

So he runs up charges on his MasterCard. The debts mount and mount until finally the minimum payment is more than his monthly pay. Costa is insolvent, as they call it in the business world. At this point he's forced to declare bankruptcy, basically telling MasterCard "I'm not paying you back".  This ruins his credit rating and he can't buy new things for a while.

But it seems Mastercard has a short memory, and after a short time, they give Costa another card and the cycle repeats.

OK, now imagine that Hans and Jacques decide they want to form a big hippie commune and all live together in a big house that they call the European Union.  They invite a pile of friends to live with them, Costa included. They all live with unlocked doors so they can trade with each other and visit more easily. Also they all share a bank account that they call the Euro, except their British friend, Elizabeth.  She was so used to having her own bank account she kept it separate from everyone elses..

Problem was that Costa still had a spending problem, as did a few of the other house mates including Luigi the Italian, Seamus the Irishman, and Portugal. Costa was the biggest problem, though, and he tried to keep his rising debt a secret. He had to ask Hans and Jacques to spot him some money to pay his bills, and they started wondering if Costa's debt was more than they thought it was.

Eventually the truth came out. Costa's sovereign debt had become so large that it threatened the stability of the whole commune. Bill collectors were coming to the door looking for their money, and Hans and Jacques were upset, both that the bills were so large and that they were sharing responsibility for them.  But Hans and Jacques couldn't just kick Costa out of the commune because they were sharing a bank account. They were in difficult times because now if Costa went bankrupt, they would all go bankrupt. But should Jacques and Hans pay for all of Costa's bills? The question of what to do loomed large overhead.

The Story - Explained

So if you haven't figured it out yet, Costa is Greece, MasterCard are the people who have lent money to the country by buying savings bonds, Jacques and Hans are France and Germany, and everyone's in trouble.

Now I am just a simple country MBA student. I am only just now taking my one required course on macroeconomics.  I don't have a fancy PhD from Harvard, and I rarely have time to read the Financial Times, but even I know they're in a dilly of a pickle.

What this means for North America

Now for us Canadians (or you Americans) it's tempting to see this in the news and think "Meh.  They're in Europe, I'm over here.  What does it matter to me?"

Well the thing is that no country is really sheltered from all the others anymore. Many Canadian and American companies have operations in Europe. Banks have branches there and global companies do a lot of business there. Globalization means European economic troubles are no longer restricted to Europe.

If Greece defaults on their debts, it means the Euro could lose its value, which means trouble for anyone who does business or invests in a European country. Exporters selling to Europe would lose business. Large multinational companies would lose profits and may start laying people off. It would have a worldwide impact.

The impact wouldn't just be restricted to big companies either.  Think of pension funds and mutual funds. They have a lot of cash and they don't just keep it in a bank account.  They'll invest it in government bonds because of the time value of money. These organizations now are at risk of losing their investments if Greece doesn't pay back their debts, and that could mean people losing their retirement. 

And that, my friends, is why the European Sovereign Debt Crisis is bad, and also why we in North America should care.

And a cat video

On a happier note, my wife and I made this cat video.  Seems our cat dances when you put a Post-it note on her head.

She got the moves like Jagger

We made this just yesterday and put it on YouTube and it got nearly 5000 views in less than a day!  Yay, my kitty is famous!


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