Questions and answers about Europe's debt crisis

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NEW YORK — After 14 summit meetings, stock market turmoil and even a fistfight between Italian lawmakers, European leaders have finally agreed on a rescue package that will stop the debt crisis there from dragging the world into recession.

That’s the hope, at least.

A bailout fund for the continent will be beefed up, and banks will take a 50 percent loss on their holdings of Greek government bonds. The banks will also put more money aside to cushion the blow from future losses.

Investors are cheering. The Dow Jones industrial average surged almost 340 points Thursday, the euro rose, and even the stocks of battered European banks gained ground.

But dangers lurk. The bank losses and the new cushion might not prove enough. The plan could exact big pain in the short term, hobbling a weak European economy. The region could still fall into recession, and drag the U.S. economy down with it.

Here are some questions and answers about what happened and what it means.

Q: What was the original problem?

A: The Greek government spent too much, didn’t collect enough in taxes and had to sell bonds to make up the difference. It ran up budget deficits well beyond limits set by the European Union, a group of 27 nations that allow goods and workers to cross their borders freely.

When Greece fell into recession two years ago, bondholders worried they wouldn’t get their money back. To make sure they did, the EU started lending money to Greece, essentially allowing it to use new debt to pay off old debt.

Greece shares a currency, the euro, with 16 countries, so its problems are Italy’s problems, and Spain’s, and Germany’s, too. And many other European countries have debt problems of their own.

The challenge was to figure out a way to fix the problem so Greece didn’t have to come back for bailout after bailout.

Q: Is the risk from Europe gone?

A: No. Even if the rescue package keeps Greece and the European banks afloat, the crisis has already damaged the European economy. Some manufacturers have slashed production and hoarded cash. Banks are demanding higher rates for loans, if they’re lending at all.

On Monday, an important economic indicator suggested business activity in the zone of nations that use the euro currency shrank in October for the first time in three years.

The European Union accounts for 20 percent of world’s economic output. It is a big trading partner for many countries. A recession there could push other economies into recession.

Q: How vulnerable is the U.S.?

A: Some good news out Thursday suggests the U.S. is in better shape to weather any blow. The economy grew almost twice as fast over the summer as it did in the spring. But it’s still dangerously weak.

Federal Reserve Chairman Ben Bernanke told Congress earlier this month that the economic recovery was “close to faltering.” And the co-founder of the Economic Cycle Research Institute, a forecasting firm that predicted the last three downturns, said a recession was all but inevitable. Consumer confidence is the lowest in two and a half years.

“It almost looks like the world is worrying itself into another recession,” Klaus Kleinfeld, the CEO of Alcoa, said Oct. 11.

One danger from Europe is that it could buy fewer U.S. goods. Europe buys 20 percent of U.S. exports.

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socks99 10/28/11 - 04:11 pm
If the world needed one more

If the world needed one more lesson in the dangers of debt, well Greece, today, is a good one.

The views highlighted in the article today do a good job of connoting the 'uncertainty' surrounding a resolution of the EU debt crisis. In reality, that uncertainty highlights two very divergent views on how policy-makers should respond to global financial and debt crisis':

1. Keynesian theorists argue that fiscal stimulus -- deficit spending -- can re-start economies and that when growth resumes, tax revenues will re-pay money borrowed to jump-start the economy. Neo-Keynesian policy on debt seems to indicate that 'bail-outs' are better than allowing market forces like insolvency and deflation to work their usual 'magic.' (This is the issue facing the EU, the US, Japan and all heavily indebted nations around the globe.) Apart from the economic policy imbued, here, remains a political calculation: That sovereign nations and their citizens are better-off when they cede political authority to stronger, creditor nations. For instance, instead of getting out of the EU, Greece is better off accepting the charity and political leadership of foreign policy-makers.

2. Traditional economic orthodoxy explains that attempts to thwart the market forces of liquidation actually forestall recovery and disrupt the 'magic' of bankruptcy that sees firms (and governments) go 'under' only to be replaced by more competitive business's that can then do a better job of managing the capital and resources previously controlled by the defunct firm. The political calculation, here, is one where local sovereign control is maintained and external debts are re-negotiated or cancelled; in such a case, political authority remains with the citizen and after a disruption in the economy due to default to foreign lenders, growth resumes and on a stronger and more sustainable basis than could be obtained under the artificial regime of 'bail-outs' from 'friendly' foreign nations.

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