Hearing the word 'Europe' conjures up familiar images of the Eiffel Tower, Colosseum, Big Ben. But now, hearing the word Europe brings thoughts of fiscal instability, high unemployment and general economic weakness. PIGS is an acronym to identify the most economically distressed nations of Europe: Portugal, Italy/Ireland/Iceland, Greece and Spain. Even England, a wealthy country, has entered a rough patch.
England's indecisive management of its economic problem stems from its political situation. The more liberal Labour Party wants to reduce spending and raise taxes on those earning more than 150,000 pounds. Alternatively, the Conservative Party would slash spending far more aggressively and reduce the tax rate for small business.
A bipartisan plan of action to save Britain becomes tougher in light of these political squabbles. If one party does not gain a clear majority in the upcoming elections, the country will have what is called a hung parliament. The ensuing gridlock will probably drive the value of the pound lower. Despite the political gridlock that threatens the country, England is probably financially healthier than Greece because of its ability to regulate its own currency. England can indirectly manage the value of the British pound. Greece, however, relies on the European Central Bank, which represents different European Union nations. This continental linkage with financially troubled Greece could also threaten the well-being of the European Union. The nation essentially spent too much money and now finds itself on the verge of default. There is reason to hope, however, if the Mediterranean nation can manage to reduce its deficit.
Across the chilly north Atlantic, Iceland is also having problems of its own. Because of massive losses, the government took control of three of Iceland's main banks in 2008. Devaluation of its currency in 2008 helped the country to obtain loans from the International Monetary Fund, an unusual borrowing by a western European nation. When these banks went under in 2008, many British and Dutch citizens - who had opened accounts in the Icelandic banks because of high interest rates - lost money when the banks became insolvent. Later, the two countries at least partially compensated their people for their losses, and Britain froze Landsbanki's British accounts, one of the responsible banks, according to The Guardian. Now with the chance to pay the money back, Iceland's citizens have voted overwhelmingly - 93 percent - to not repay England and the Netherlands.
Farther south, Spain's problems differ from those of Iceland. Spain is currently suffering from high unemployment. The Bank of Spain has forecasted that the nation will hit an unemployment rate of 19.4 percent this year - far above the 9.6 percent of the countries in the European Union as of February. Part of the reason for this high unemployment was Spain's unrestrained construction boom. Southern Spain is a bit like Florida, a mild climate with beaches where sun-starved northern Europeans flock. As in Florida, a housing bubble occurred - too many houses were built, and too many people bought houses they could not afford. With construction grinding to a halt now, there is sky-high unemployment. The risk here is that unemployment will cause a domino effect. Unemployed people cannot buy goods and services, creating less demand and causing more jobs to be lost. This, combined with a rising budget deficit, has created difficulties for Mr. Zapatero, Spain's prime minister. Spain has to balance the conflicting aims of increasing unemployment benefits for its jobless citizens with spending cuts and raising taxes to strengthen the country financially.
Spain's neighbor across the Mediterranean, Italy, seems to be faring slightly better. Unemployment in this country was 8.6 percent in January according to a Bloomberg article, far below Spain. But Italy's GDP recently fell unexpectedly, likely related to the falling industrial production. With a somewhat high deficit and strikes occurring too often for comfort, efforts at financial prudence may spark outrage. Also, Italy has a higher Corruption Perception rate, as calculated by Transparency International, than some other western European nations.
With all of this gloomy news, what can investors do? First, savvy investors can buy Credit Default Swaps on a country's bonds. These CDSs work as insurance; the investor pays a monthly premium and if a country defaults on its bonds, the investor collects on the insurance. Investors also can sell euros and pounds and flock to safer currencies like the U.S. dollar.
Despite these problems, analysts say it seems unlikely that the European Union will collapse anytime soon. If Greece or other nations defaulted, it would be much harder for them to borrow money in the future, so they have a strong incentive to take the necessary steps to live within their means.
Harrison's column runs biweekly Thursdays. He can be reached at h.freund@cavalierdaily.com.
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