A beginner's guide to the EU crisis

Activists of the Occupy Frankfurt movement have set up a fireplace near the Euro sculpture in front of the European Central Bank in Frankfurt, Germany Nov.3, 2011. The ECB announced to lower their key interest rate to 1.25 percent. AP Photo/Michael Probst

(MoneyWatch) Q: What is happening in Europe?

A: Several nations which use the euro as their common currency are having severe financial problems because of either a collapsing real estate bubble or over-spending by the government. Ireland, Greece and Portugal have gone bankrupt and now rely on loans from the European Union, International Monetary Fund and European Central Bank to pay their bills.

Q: Why is everyone so concerned about Spain?

A:The government of Spain is broke and can no longer borrow money on the open market to pay its bills. Last Thursday, Spanish Budget Minister Cristobal Montero said, "There is no money in the public coffers." Spain cannot borrow because investors are so worried about the nation's ability to repay its debt that they are charging interest rates which the nation cannot afford.

Q: How high are these rates?

A: In order to borrow money for either 5 or 10 years, Spain would have to pay around 7.5 percent interest and nearly 7 percent to borrow for two years and it can't pay that much. The 7 percent mark for the 10-year bond is viewed as critical because it makes borrowing money unaffordable. Ireland, Greece and Portugal all asked for bailouts within a month of their 10-year rates hitting that level. None of those nations' 2-year or 5-year bonds were as high as Spain's currently are when that happened.

To put this in perspective: The U.S. is paying 1.4 percent to borrow money for 10 years and the Swiss are being paid 0.3 percent to borrow money for two years.

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Q: Why would anyone pay a nation to lend it money?

A: Negative interest rates are a sign that some investors are so nervous about the economy they are willing to pay to keep their money safe. The last time that happened in the U.S. was during the Great Depression. In addition to Switzerland several other nations which investors think are safe - including Germany, Japan and Finland - are charging interest in order to borrow money for short periods of time. The United States is charging 0 percent on all bonds lasting a year or less. If you factor inflation into the equation the rates are effectively negative.

Q: What is Spain doing to solve its problems?

A: The government has cut its budget several times. However, the nation is in a recession and has an unemployment rate of more than 23 percent, so these budget cuts are likely making the economy worse.

In addition to that, Spain has asked the European Central Bank to take emergency action to ease its government borrowing rates. In the past two years, the ECB has bought bonds on the open market, lowering their yields, or interest rates. It has also given banks $1.22 trillion in cheap loans to banks to ensure they have enough cash to lend to the economy. But these measures have only temporarily lowered government borrowing rates. The ECB claims the measures are no longer effective in fighting the crisis and that governments need to take action by, among other things, sharing countries' debt loads.

Q: Will the EU do that?

A: While several proposals have been put forward to create Euro-bonds that could take a year or more to enact and Spain doesn't have that much time.

Q: How much time does Spain have?

A: No one can say for certain but many analysts are saying that it is at most weeks. It could be less.

Q: Will the EU be able to bailout Spain?

A: Spain is the world's 14th largest economy in terms of GDP and most observers believe that it is "too big to bail." Spain's public debt is currently at least $1.192 trillion or 80 percent of its GDP. As a point of comparison: Greece's public debt is about $450 billion

Q: What else can be done to avert the crisis?

A: Of the suggestions put forward so far, the only one which could happen soon enough is the ECB issuing a lot more money which would be used to push bond yields lower. However it is important to remember that when the ECB was set up Germany - which has the strongest economy in the EU - insisted on rules in its charter to keep the money supply steady. Since World War II German economic policy has always focused on a stable currency. The Germans are almost culturally afraid of recreating the hyperinflation of the 1920s which devastated their nation and lead to the war. Creating more money is not usually how you maintain a stable currency.

  • Constantine von Hoffman On Twitter»

    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.

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