What Investors Need to Know About the Eurozone

The Eurozone has dominated a lot of headlines over the last few years. This article is going to offer a brief overview of what the Eurozone is, and why it’s important for financial markets and investors. It is also going to dig into the on-going Eurozone crisis and provide some details that investors need to be aware of.

Differentiating the Eurozone from the European Union

First thing’s first, the Eurozone should not be confused with the European Union. Every country that is a member of the eurozone is also a member of the European Union. However, not every member of the European Union is a member of the Eurozone. In fact, only 19 out of the 28 members of the European Union are euro countries, meaning they are part of the Eurozone.

The euro zone, or euro area as it is often called, refers to the 19 countries that use the euro as a common currency. If you go to France, Germany, Italy, and many other countries, you will find that they do not use their own unique currencies. Instead, they all use a common currency that is simply called the euro.

Currency

Some countries that are members of the European Union, like the United Kingdom, elected to use their own currency, in this case the pound. ( The U.K. is currently in the process of leaving the European Union, but as of writing this article, was still a member.) Most countries that are members of the European Union, with the exception of the aforementioned U.K. and also Denmark, are obliged to join the Eurozone once they meet certain criteria.

A few countries have adopted the Eurozone unilaterally, meaning the currency is in use. However, they do not have the representation granted to formal members in the Eurozone’s governing bodies. These countries include Kosovo and Montenegro.  A few other countries, like the Vatican, Andorra, Monaco, and San Marino also use the Euro. These countries, however, are not actually members of the European Union. The global community generally consider these countries micro-states.

So What is the Euro Crisis?

The on-going euro crisis refers to the unfolding crisis in the Eurozone that is the result of some countries doing a poor job of managing their finances (for the record, this is a bit of a simplification). Greece, Italy, Portugal and to a lesser extent Spain and a few other countries are heavily indebted. Their governments overspent for years and did a poor job managing their fiscal policies.

Greek debt has now reached an astounding 175% of the national economy. By comparison, France, which is another country that draws flack for overspending, has a debt-to-GDP ratio of “only” 93 percent. In Italy, debt-to-GDP has reached about 132%, and in Portugal it’s 128%. Meanwhile,  in Spain it is at a healthier 94% but debt levels have been skyrocketing.

The eurozone crisis has emerged as one of the biggest issues in the world of finance. At various times over the last few years, it has threatened the stability of the entire global financial system. Greece has stabilized as of late, but it may only be a matter of time before a Greek-borne crisis emerges again. Greece’s finances are still in very poor shape, and harsh austerity measures have hurt the local economy.

Bigger Risks Ahead

The bigger risks are if an even larger Eurozone member becomes insolvent, such as Italy. Compared to Italy, Greece is a much smaller country and has a much smaller economy. As a result, other members of the Eurozone have been able to keep Greece afloat through loans and other forms of financial assistance. If Italy were to suffer a full-blown crisis, it might be too large for other Eurozone members to bail out.

When countries joined the Eurozone, they were supposed to adopt fiscal policies in line with the Eurozone. Unfortunately, many countries failed to do so. In Greece’s case, government officials actually “cooked the books” and misrepresented numerous things. Many Eurozone members didn’t realize there was a crisis until the crisis actually set in.

In other cases, enforcement of Eurozone policies has been lax, and governments have generally been able to do as they please. Even following the crisis in Greece, many countries have continued to spend well beyond their means without penalty.

Impact on the Euro

This is an important issue because currencies are supposed to reflect the health of their respective country. If Greece had its own currency, the value of that currency would have plummeted following their debt crisis. This wouldn’t have necessarily been bad. In fact, a dropping currency encourages foreign investment and exports, among other things, which can help revive sinking economies.

With the Eurozone, however, the euro has remained relatively strong based on the stronger performance of Germany and other countries. The euro has weakened considerably versus other countries, but is still a relatively strong currency. This means Greece must continue to use a strong currency, even as its economy is weak. Arguably, this is bad for Greece. At the same time, the weakened euro and crisis caused by Greece and others is bad for stronger economies, like Germany.