#2 Before the crisis in Europe – Rates convergence, the heart of the problem


In this article, we will mainly focus on the consequences of the adoption of the euro in Europe and on the euro crisis. As Paul Krugman says it, financial crisis in Europe is a bit different than in the US in the sense that there was less fancy finance.

Contrary to what can be heard, the euro crisis is not a sovereign debt crisis. In other words, the explosion of the public debt is not the main reason for the recession Europe is actually living under. Even though this explanation can be applied to the Greek case, it is wrong to assume that Europe is suffering from the same ills. Paul Krugman argues that what is at the heart of Europe problem is actually the convergence of interest rates that followed the introduction of the euro currency.

Before the Euro, interest rates have been pretty unequal among European countries. Historically, north-countries benefited from better credit conditions than south-countries. This was regarded  as a premium investors would get for investing in “riskier” countries. The introduction of the Euro however radically changed the game. Moved by the hope coming from the creation of the EU, investors slowly began to regard any European countries on equal terms. We then assisted to a veritable convergence of interest rates among European countries. Spain could for example borrows with close to the same rates as Germany. The following graph clearly shows this rate convergence post-EU.


Figure 1

For the clarity of the argument, I decided to only focus on Spain, not only because their food is excellent, but also because it gives good insights on the problems Europe is now facing. As I said, Spain, among other countries, has been able to finance itself with more advantageous conditions as before the introduction of the single currency. Surfing on this new status, public  and private spending drastically increased in the years following the entry. Spanish banks quickly needed to turn towards other countries’ banks in order to meet all the demand of credits. German banks were notably among the banks that lent the most to the public and private Spanish sector. Basically, capitals were flowing from the heart of the Europe towards its periphery.

As the economy was developing, so did Spanish wages. During the first ten years following the introduction of the single currency, wages’ (that comes as a cost) increased by 35% in Spain while it only increased by 9% in Germany. Pretty similarly to the American case, it’s important to know that the increases in credits were mainly concerning the housing sector. This increase of capital lead to a housing bubble. Once the bubble burst, Spanish economy had to find alternatives. They notably tried to revive the manufactory sector but the harm was done. Spanish economy was not competitive anymore. Exports could then not develop as what would have been needed. As we have seen, imports were high. This consequently lead to an explosion of the commercial deficit of the country. The heart of Spain’s problems is that lack of competitiveness that prevents it to revive its economy.


Figure 2 : Nous voyons ici la claire explosion du déficit commercial pour les pays déficitaires comme l’Espagne alors que les pays prêteurs tels que l’Allemagne voient leur balance commerciale augmenter.

One reasonable question would be why Spain didn’t simply reduce its wages in order to regain the competitiveness? While it’s true that such an operation would have been extremely helpful for the country’s economy, it is also true that it is extremely difficult to implement, given the parameters. We wills see in next articles the tight relation there is with the introduction of the single currency.

Even though financial crisis in the United States triggered the European crisis, it is likely that a crisis would have happened anyways. European problem is deeper and is tightly related to the single currency topic.


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