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2011 European Debt Crisis

Imagine for a moment that you are one of the few lucky individuals in the world born into oil wealth. From the moment of birth, to the current setting of your life, money has never had to have been a concern. An oil prospecting company started by your family generations ago has enabled your parents, and their parents, and now you to live comfortably without ever encountering the question of economic viability.

Living a life of privilege, you enjoy this benefit. Vacations, quality of life and the simple fact that you don’t have to scratch up capital to further substantiate your existence has led to a very comfortable existence. Let’s develop our story further and imagine you have thirteen brothers and sisters enjoying these same benefits, with siblings both younger and older. Money has never been a chief concern for them either, life has always been comfortable.

Through the generations, economies face recessions, down-turns, and crashes; but your families security with its generations of wealth and large holdings of oil-bearing real estate, is never in question. This family wealth has created stellar credit with lending companies, as they realize the deep pockets that have built your family’s name are likely there to support any loans you may request. The thought of you, or your family, defaulting on personal debt is ludicrous; so these lenders have no problem allowing you to borrow as much as you might want as they have relative assuredness of being paid back. This was all propagated by Oil exploration that took place in your family generations ago.

Debts are really no big problem because money has always been coming in, enabling you and your siblings to pay all interest and principal back to creditors in a timely fashion. Banks feel good about the relationship; because you always pay them back and they make interest on the deal for their trouble.

Low inheritance taxes in the United States has allowed your distant relatives' financial boom to filter all the way down to you and your 13 siblings; and with demand for oil being as inelastic as it is, your family hasn’t had to worry about diversifying their income stream. In Texas, where I’m from, this is really not all that uncommon.

Now, let’s say for a moment – that this scenario changes. Let’s assume that the miracle of a viable alternate energy solution actually presents itself. Oil, with its limited supplies, high cost, barriers to production, and of course – Greenhouse affects, has long been the scourge of environmentalists and Global Warming advocates. This new alternative energy solution is clean, cheap, and easy to reproduce.

Your family’s wealth, entirely based in Oil, is now a question. But, for the time being, there is nothing to worry, as the banks know that you’ve always paid back your debts on time and they are willing to extend credit.

So you and your siblings all take out credit. Remember, money has never been a problem for your family so it will probably be difficult to imagine life in any other way. At this point, it’s difficult to forecast that for the first time in your life; you might actually end up poor. All you see is that money is available, and you need it, so you take it and worry about paying back later.

Fast forward 3 years. Our miracle energy solution continues to lessen demand for its dirtier, more costly, less abundant competitor (oil). As demand decreases, market prices of Oil decrease accordingly. Then Oil companies have become affected, seeing profit margins narrow to the point where they’ve had to begun laying people off; contracting their future financial scopes.

To pay living expenses, you continue to take out loans. But the bank that lent you the money is beginning to realize that you might not be able to pay it back this time, so they cut off your credit line. No more money is coming in from the oil company, because that is losing money too. So you go to your brothers and sisters. You let them know your trouble, you beg for their help because if you don’t get it – you very well may default on your loan to the bank; and with no more money coming in from the Oil company, well…. The game would be over. You’re not the only one, only five of your brothers and sisters had the foresight to set up private trusts to save the revenues accrued from your families’ Oil company endeavors. You and the other 6 brothers and sisters are all cash flow negative, spending more money than you make every single month.

Your brothers and sisters that had saved; well they are unhappy about your poor decisions, misuse of credit, and haphazard ways of spending. They tell you they will help you out until you get back on your feet, but you have to show them you are at least trying to fix the situation by lessening your spending habits. You HAVE to show progress for their continued help. And you try. You genuinely try your best.

Unfortunately, your best is just not good enough. After a life of luxury, living on a hairline budget is not something you are very good at doing. Cash flow continues to be negative, and you continue to rely on the assistance of your forward-thinking brothers and sisters that saved their Oil wealth. Of the other six brothers and sisters that spent all their money alongside you, three have gotten their act together, seeing a financial planner to put together a budget and plan of action to getting out of debt. They are on their way to recovery.

Now it’s just you and three brothers and sisters that are requiring assistance, but your forward thinking siblings are still not happy about being forced to support you. Your finances are in such dire straits, that you can even get a loan on your own anymore. Banks just don’t trust you. The only way you can get any help is with the guarantee from one of your credit-worthy brothers or sisters.

But now their credit is starting to take a hit, as the banks realize that they are supporting you and your delinquent siblings.

What happens from here?

This situation is very much like what occurred during the 2011 European Debt Crisis. After generations of economic prosperity at the top of the free world, the game changed; much like the fictitious advent of an alternative form of energy in our example.

This changing global economy with new participants such as China, India, and Brazil completely altered the way that the industrial production takes place on a global scale. To offset any changes in lifestyle brought upon by this global shift in economic production, debt was taken out – without ever thinking that it might not be paid back, just as you had fictitiously taken out lines of credit to continue to support your lifestyle in our example.

In our example, as change continued to take hold of the market place, we refused to change our habits with it. We stuck to our way of life convinced that we would never have to let go. Because we refused to change, we continued digging ourselves deeper and deeper into a financial hole. This is how Italy and Greece got to debt levels of 120% of their Gross Domestic Product. They refused to change. The change necessary to fix this problem is ‘austerity.’ The topic often discussed, thrown around, and suggested with the European Debt Crisis is also the goal with which most failed.

Just like in our example, in which some of your brothers and sisters get their act together – we have Ireland, who recognizes there is a problem and without a solution, well, they recognize their own fate is at question. So they fix it.

Unfortunately this isn’t easy so Portugal, Italy, Greece, and Spain continue to flail in the wind hoping for a solution.

Just like our brothers and sisters in the above example, the credit-worthy participants in the economy such as Germany, France, The Netherlands, Austria, Belgium, Finland, and the UK are beginning to be affected by the malfeasance of your brothers and sisters that are having difficulty changing to the point of being able to solve the problem. They continue to need to borrow money without any real fix in store.

And that brings us to the current state of affairs. While numerous resolutions have been discussed, nothing has yet to satisfy markets in European Debt.

--- Written by James B. Stanley

To contact James Stanley, please email Instructor@DailyFX.Com. You can follow James on Twitter @JStanleyFX.

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