European leaders did not meet their goal of making an announcement before the Asian markets open, but they eventually made a whopping announcement. European leaders announced the creation of a bailout package between 720 to 750 Billion Euros ($962 Billion). The money is supposedly coming from the following sources:
- 60 Billion Euros from the EU's budget.
- 440 Billion Euros from European governments (needs to be raised).
- 220 to 250 Billion Euros from the International Monetary Fund (IMF)
Here is my reaction to the announcement made by European leaders.
The EU’s plan should bring some temporary stability in the short-term because it gives European countries access to emergency funds if needed. However, the plan may not work in the long-term because Europe is heavily in debt.
- This plan appears to call on European governments to accumulate more debt to finance this bailout fund. By borrowing money to finance this bailout fund, participating EU members will make their own domestic fiscal situations worse by putting themselves in more debt.
- In addition, what is the EU going to do when the fund runs out of money? Greece is a comparatively small country, yet it was lent 110 Billion Euros (which actually isn’t enough). A few larger European countries could exhaust the fund if they run into severe financial difficulty (i.e. Spain and Italy). At that point Europe will be in potentially greater trouble than it was last week since it is unlikely they will be able to finance a new bailout fund with more borrowed money. Bond investors would be sick and tired of lending the EU money.
According to one financial market journalist, the EU’s plan creates a de facto EU Treasury. If such an entity is created, its development would be something to watch closely. A European Treasury is a step towards encouraging eventual political union because for a European Treasury to succeed in the long-term EU members eventually would need to come up with common budget-making and taxation decisions.
Finally, Americans should be aware that their taxpayer dollars are being diverted towards financing this bailout fund. The astounding sum the IMF is contributing could put U.S. taxpayers on the hook for potentially up to $48 Billion (or more).[1]
In the end, it’s hard to harshly criticize the choice European leaders made. On Friday night European leaders were privately warned that if they did not come up with a major plan soon Spain and Portugal would not be able to afford to borrow money from the market within a few weeks; causing a massive financial chaos throughout Europe and the world. European leaders had to do something or risk having the global economic and financial system completely collapse now. Although European leaders have delayed a collapse, the collapse will eventually come because the main problem still remains: too much debt.
Note
[1] 220 Billion Euros x 1.29 (EU/USD Exchange Rate) x 17% (the American contribution to IMF Loans)
