Here is a quick synopsis of the European debt crisis.
Many of the European countries, especially Portugal, Ireland, Spain and Greece spent and borrowed a lot of money during the good times. The bills eventually came due and they did not have the money to pay back the loans. So they started borrowing more money to pay back the maturing debt. Only this time the interest rates that they need to pay out have gone higher. Interest costs have gone up.
Many of the PIGS countries can not borrow money as cheaply as they did years ago. So now they are faced with skyrocketing interest costs, especially Greece. They were forced to get loans from the IMF and EU at around 5% interest rates. Which are a bargain compared to what they would of gotten had they tried to borrow from the market.
Greece especially is faced with the problem that they have all this debt and interest to pay back, but tax revenue is not growing. Unemployment is skyrocketing, tax evasion is rampant. Even when the economy grew it was difficult to see federal tax revenue grow in those countries. So now you have Greece having a lot of unemployment and negative GDP growth. It’s very tough to pay back loans when the economy is not growing and you have to pay high interest rates.
The EU doesn’t want to let Greece default because they are scared that it will create too many losses on many European Banks that hold Greek debt. They are scared if they let Greece default that it will create a Lehman Brothers like event. And if that happens the risk of bank runs starts to creep higher as people start yanking their money out of the banks. Then it starts to spiral out of control.
They want to avoid that scenario as much as they can so have thrown so much money at Greece and lifelines to other countries to avoid that scenario.
They are hoping that Greece will be able to raise money through state asset sales. Greece has a lot of potential money that they can raise if they sell state assets, land etc. Estimates are they can raise $50 billion. Only problem is that executing the plan is almost impossible as the bureaucracy and red tape in the country is very high. Even if they happen to raise the money, that is just one influx of cash. What they need is recurring revenue growth, but they don’t have that because unemployment is high, growth is negative, and tax evasion is rampant.
Now you may ask how can that explain the EUR/USD movements for today? The answer is it can’t. It’s goal is to help you realize why the Europeans are doing what they are doing. To better understand the global macro environment, which can help in identifying potential stresses and fractures that can occur. Because if they do occur, or markets believe they can occur, they can generate substantial order flow.
You may ask what are the possible solutions to the crisis? I leave that to the politicians and voters in their respective countries to figure that out. It doesn’t matter whether I know what the solutions are that can solve their problems. The politicians and voters will do whatever they want. What is important is NOT to focus on what the solutions to the debt crisis are. The important things are to focus on how to profit from whatever scenario unfolds, whether good or bad for debt crisis.
Play out scenario analysis for the EUR/USD at 1.70 or 1.00