The eurozone has agreed a new "fiscal compact’ Eurozone leaders have agreed to a tough sot of rues - insisted on by Germany ~ that wil mit their governments borrowing each year to just 3% of thelr economies’ output. This is supposed to stop them accumulating too much debt, and make sure there won't be another financial rss But didn't they already agree to this back in the '90s? Hang on a minute. They agreed to exactly the same 3% borrowing mt back in 1997, when the euro was boing set up. The "stably and growth pact” was insisted on by German finance minster Thoo Waige! (contre of image). What happened? So who kept to the rules? 3/9 Italy 5/9 Germany 6/9 France 9/9 Spain Worst offender First to break rules ‘Offender Top of the Class tly was the worst offender. It regulary broke the 396 annul borrowing limit. But actually Germany - along with italy - was the fst big country to break the 3% rule. After that, France folowed. Of the big economies, only Spain kept its nose clear untl the 2008 financal crisis; the Madrid government stayed within the 33% limit every year from the euro's creation in 1989 unti 2007. Not only that - of the four, Spain's government also has the smallest debts relative tothe size ofits economy. Greece, by the way isin a class of is own. I never stuck to the 396 target, but manipulate its borrowing statistics to look good, which allowed it to get Into the euro inthe fist place. Its waywarciness was uncovered two years ago. But the markets have other ideas ‘So surly Germany, France and Italy should be in trouble with all that reckless borrowing, while Spain should be reaping the rewards of is vitue? Wel, no. Actually Germany isthe ‘safe haven’ - markets have been willing 10 lend to iat historically lw intrest rates since the crsis began. Spain onthe other hand is seen by markets as almost as risky as Italy. S0 what gives? Government borrowing cost annual interest rate" 2% 7% H ray cs Spain 3% % France 1% a Germany 1% Jan 08 Jan 08 Jan 10 Jan tt 0:jar benchmark gouemment bon yi Source: Bloomberg So what really caused the crisis? There was a big build-up of debts in Spain and taly before 2008, but ithad nothing to do with governments. Instead it was the private sector - companies and mortgage borrowers - who were taking out loans. interest rates had fallen to unprecedented lows in southern European countries when they joined the euro. And that encouraged a debt-fueled boom Total Debt as a percentage of annual economic output” Government debt Ml Private debt Germany "Nonfnaneia sector dais a a pecertage of GOP Source Bank lor ntenatina Setements Good news for Germany. Altat debt hlped ance mre and mare imports by Spin, aly and even France. Meant, Garmany became an export powerhouse tre eurozone was et UP i 109, sling far more othe resto the Wor {niucing southern Europeans) than # was buying es mporta, Tet meant Germany wes earning 8 of supa anh one expos. And guess whet - most of tat cas ended up bang ln to soutarn Europe Trade deficits* 10% % om Germany *“ France tly Spain 10% 99 2000 2001 2002 2003 2004 2008 2006 2007 2008 00910 ‘Curent acount lane a percentage of GOP Source rst .bad news for southern Europe But debts are only part of the problem in Italy and Spain. During the boom years, wages rose and rose in the south (and in France). But German unions agreed to hold thei wages steady. So Italian and Spanish workers now face a huge competitive price disadvantage, Indeed, tis loss of competitiveness isthe main reason why southern Europeans have been finding it so much harder to export than Germany. Labour costs 180% 10% ‘Spain tay France 120% so0% Germany 20% 860 2000 2001 2002 2008 2004 2005 2006 2007 2008 2000 2010 20m “dead ubcurcoss, seasonal acd Sure: gman fr Eeonaie Co-peaon and Delopent ~ and a nasty dilemma oto recap, government barowing- which hs ballooned since the 2008 global nancial eri had very itl todo wth erating the eure eurozone raisin te ft place, expectalyin Spain (Gre000's {overnment sth big excopton here So oven i governments dont break the orowing rules his time, that won’ necessary stop a simlar cei rom happening al over again. ‘Spain and tly are now facing nasty receesions, because no-one wants to spend. Companies and mortgage borowers are oo busy repaying thoi debs to spond more. Exports are uncompetitive. And now ‘overrments- whose borowing has exploded since the 2008 financial {isis savaged ther economies“ have agreed to caste ut their Spending back es wel Bt. Cut spending. Don’t cut spending and you ar prety sue te deepen th recession. and you rlsk a nancial colapse. The amount you That probably means even more unemployment borrow each year has exploded since 2008 veto (already over 20% in Spain), which may push wages ‘economic stagnation and high unemployment. But your down to more competitive evel - though story tconomy looks to be chraiealy uncompattive win suggests tis very har odo, Even 0, lower {he euro, So markets are abe to lose confidence in wages wl ust make people's debts even harder to yous they may fear your economy is smpy too weak repay, meaning they are Ikaly to cut thei own to suppor your ballooning debtoad. Meanie, other spending even more, or stop repaying thi debts. Exropean governments may not have enough meney to Aad lower wages may not even ead oa cick se bal yu ou, andthe European Cental Bank says te in exports, al of your European export markets are ‘mandate doosr't alow tt. And they wor lend to infecesion too. In ary case, you can probably you, why would anyone le? expect more strikes and protests, and more nervousness in nancial markets about whether you really wil stay in the euro