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Europe Debt Crisis Explained. Who Owes Who What And Who Will Be Hurt Most From Spain or Italy Defaulting

If you woke up in a good mood this morning, it would only have lasted until you switched on your television and heard that two major French banks, Societe Generale and Credit Agricole, have been downgraded by credit rating agency Moody’s. This is the latest development in the rapidly escalating disaster we know as the Europe debt crisis. When exactly did this start and why? Who will be the major losers if Greece, Italy, or Spain should go under?
It is indeed very difficult to explain in layman’s terms what exactly is happening in the major European economies when most economists seem unable to do so.
Things started going wrong towards the end of 2009 and by the beginning of 2010, it was clear that certain European countries are going to have serious problems meeting their debt commitments. These included Greece, Ireland, Spain, and Portugal, but the list has since grown to include Italy and the ripple effect is starting to effect even countries such as France.
The core of the problem was most likely irresponsible lending by banks. A credit bubble was created through banks lending out money to individuals and businesses to acquire assets that proved to be worth less than the amount of the loans. This was especially true in the real estate sector – something we also saw happening in the United States.
When these banks got into trouble because of bad loan practices, the government had to bail them out using public funds. This happened in the United States and it was repeated in Greece and other European countries.
The government of course has no money of its own – it has to raise it either through taxes or through loans. Since tax money is normally used to finance the current budget expenditure, the money to bail out banks had to come from loans. What therefore happened is that the US, Greece and subsequently other European governments issued government bonds to finance these bailouts.
The problem with government bonds is that you have to pay interest on them and when the market starts doubting your ability to repay the loan, the interest rate will become higher and higher. In the end it is a downward spiral – the government takes up more loans to roll over existing ones, but the interest rates keep on getting higher and higher.
The next step in this evil spiral is that countries, who actually managed their finances perfectly well, such as Spain, are also caught up in the web – because they are invested in the government bonds of the ‘rotten apples’ such as Greece.
This is exactly what has happened to the two French banks in question: they were heavily invested in Greek government bonds – which might soon prove to be worthless if the Greek government should default on its debt payments.
What it all means is that we have an interconnected web of debtors and creditors here and if one goes down, he might very well take down the rest with him.
Italy, for example, owes France $550 billion dollars – which is nearly 20 per cent of the French GDP. If Italy goes down, one can understand how badly it will hurt France.
Spain owes France, Germany, and Britain more than $500 billion, so all of them are rightly scared of a collapse in Spain.
France undoubtedly has the most to lose from a Spanish or Italian collapse: these two countries combined owe the country more than $700 billion.
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