As markets lose billions of pounds in value this week, Harry Wallop explains how the crisis came about and what it all means.
7:47AM BST 06 Aug 2011
Q. Why have stockmarkets fallen so heavily this week?
A. Markets falls when there are more sellers than buyers. Investors around the world have become increasingly nervous about where to put their money, amid fears of the global economy entering a fresh recession and the entire Eurozone area collapsing because of mounting Government debts in Italy and Spain. As a result many investors – both private and the institutions who invest our pension funds – have started to sell.
Q. So how serious is the risk of another global recession?
A. Ironically, many British companies, especially engineering firms, have reported stellar financial results this week, announcing to the London Stock Exchange that they have never enjoyed such good business on the back of a resurgence in global travel and trade.
America reported a better-than-expected improvement in unemployment on Friday.
But there are some signs that China, whose booming middle classes have helped keep global consumption above water, is starting to slightly slow down. And many economies such as Italy, America and Britain are barely moving forward. Families here, and around the world, reacted quite sensibly to the financial crisis of 2008 and started to pay off their own household debts and save a little bit of money.
While this was very sensible for individual families, it was disastrous for the economy – it meant people stopped spending, causing problems for the high street.
Q. And the Eurozone? Why is it in such poor shape?
But there are some signs that China, whose booming middle classes have helped keep global consumption above water, is starting to slightly slow down. And many economies such as Italy, America and Britain are barely moving forward. Families here, and around the world, reacted quite sensibly to the financial crisis of 2008 and started to pay off their own household debts and save a little bit of money.
While this was very sensible for individual families, it was disastrous for the economy – it meant people stopped spending, causing problems for the high street.
Q. And the Eurozone? Why is it in such poor shape?
A. It's all to do with debt. Governments in Europe have just too much debt and there is a real concern they cannot pay back their creditors.
Much of this problem has come about from the financial crisis of 2008, when governments around the world propped up the banking system – also saddled with too much debt – by transferring many of problematic loans from the private sector to the public sector. In Britain, this manifested itself in the taxpayer buying majority stakes in Lloyds Banking Group and RBS.
Many governments also reacted by pumping taxpayers' money into the economy. While this staved off a global depression, it merely delayed problems rather than solving them.
Last year, Ireland had to be given an emergency loan, so too Greece. Earlier this year Portugal and then Greece again had to be bailed out.
Now the spotlight has turned to Spain and Italy. Quite simply these countries are not earning enough – from tax receipts – to pay off its debts. And the two countries' debts together are an eye-watering £2 trillion.
Italy's debt stands at about 120 per cent of gross domestic product (GDP) – or in other words, a fifth more than the country's annual economic output – and is one of the highest in the world.
Q. Can't the European Central Bank step in?
A. In theory, yes, it could. But its special backup body, the European Financial Stability Facility has just €440bn (£382bn) of firepower, not enough to cover Italy and Spain's debts of £1 trillion, and though this figure is meant to increase not all countries have signed it off.
European countries are split as to whether they should pump more money or not. This sense of indecision from politicians is not helped by the fact many are on holiday this week.
Q. Why does it matter if Italy or Spain defaults?
A. Because the people who hold Spain or Italy's debts are indirectly millions of ordinary consumers around the world. That's because Governments raise money by selling bonds – in essence IOUs. These are bought by banks and institutional investors, on behalf of ordinary pension funds, on the understanding the government will pay an annual interest payment and return the full amount of the loan when the bond "matures", either after a few months or a few years.
If a Government defaults, it can't pay its bondholders. That's you and me.
http://www.telegraph.co.uk/finance/financialcrisis/8684246/Stockmarket-crisis-QandA.html
http://www.telegraph.co.uk/finance/financialcrisis/8684246/Stockmarket-crisis-QandA.html
