Skip to main content

How the euro crisis will affect you

By David Frum, CNN Contributor
May 22, 2012 -- Updated 0957 GMT (1757 HKT)
Schoolchildren walk past drawings and a slogan on a wall in the center of Athens in February.
Schoolchildren walk past drawings and a slogan on a wall in the center of Athens in February.
STORY HIGHLIGHTS
  • David Frum says the European financial crisis is not about debt, it's about currency
  • He says some countries unable to borrow in euros with limits set by European Central Bank
  • Their escape hatch: Quit the euro. Ensuing credit-card debt could have global effect
  • Frum: U.S. financial portfolios could suffer because of how world financial institutions work

Editor's note: David Frum is a contributing editor at Newsweek and The Daily Beast and a CNN contributor. He is the author of seven books, including a new novel, "Patriots."

(CNN) -- The European financial crisis is poorly understood in the United States.

Because so many Americans misunderstand the crisis, they fail to appreciate how -- and how much -- the crisis threatens them.

Americans tend to think (and are encouraged by politicians to think) of the European crisis as a debt crisis. Governments overspent, got into debt, and now the day of reckoning is at hand.

David Frum
David Frum

Yet that version of the case is demonstrably untrue. Spain's debt-to-GDP ratio is substantially lower than that of the United States. Germany's debt-to-GDP ratio is neck and neck with the United States. Yet it is Spain, not Germany, that is in trouble.

Europe is not having a debt crisis. It is having a currency crisis. It's not that European countries have bumped up against their ability to borrow. The problem is that some European countries are bumping up against their ability to borrow in euros. That limit is imposed not by markets, but by the European Central Bank.

Rehn: Euro is better off with Greece
London a safe haven for eurozone money
Italians talk Greek eurozone crisis
Satire novel exposes hypocrisy in D.C.

Nobody doubts that the U.S. can generate dollars to pay its bills. Nobody doubts that Japan can generate yen, or that Britain can generate pounds sterling. But they do doubt that Spain or Italy can generate the euros they need, because -- unlike the U.S. or Japan or Britain -- Spain and Italy lack the power to create their own money. Maybe not Greece, which is a special case, but the other troubled countries could recover their borrowing ability tomorrow if they quit the euro and resumed their former national currencies.

Americans need to understand this truth, because otherwise they will be blindsided by the real risks out there.

The hard-pressed countries of the eurozone have an escape hatch: They can quit the euro currency. Quitting the euro would not be pain-free -- but it might well become a less painful alternative to what those countries are suffering now: Great Depression levels of unemployment, rising taxes, massive social security cutbacks. Over the past two years, for example, Portugal has cut government spending by almost 8 points of GDP. To achieve the same scale of cut in the United States, we'd have to abolish both Social Security and Medicare.

The sacrifices countries make to stay inside the eurozone fall mostly on their own people. But if they quit, the pain is exported -- and will be heading our way.

Consider for example a working Spaniard, earning, say, 40,000 euros a year and holding a 2,000 euro balance on his credit card.

Spain quits the euro. The Spaniard's salary is converted from 40,000 euros to 40,000 new pesetas. Quickly, the new peseta loses value against the euro. A month after the conversion date, the Spaniard's 40,000 new pesetas are worth only 20,000 euros.

He is poorer than he was. But at least he's working. At Spain's new lower wages, other Spaniards quickly find work too, just as Americans rapidly went to work when the U.S. quit the gold standard in 1934. Imported goods become more expensive. But not rents -- they are denominated in new pesetas too. When our Spaniard buys his morning cup of coffee, the beans will be more expensive and the sugar too. The wages of the barista who makes the coffee, however, will have declined in tandem with his own. Ditto the mortgage on the coffee shop. And those nontraded inputs account for most of the cost of the cup.

Now look at the other side of the ledger, the Spaniard's debt. What happens to that 2,000 balance on his credit card? It is (presumably) also redenominated into new pesetas. It also falls in value, to just 1,000 euros. Good news for the Spaniard. Bad news for the credit card company.

Or is it?

In the 2000s, Spanish banks emulated U.S. banks in the aggressive use of securitization. As of 2010, the European Central Bank reports, Spanish banks had issued more asset-backed securities than the banks of any other European country except the Netherlands -- and vastly more than the banks of France and Germany combined.

Which means that our Spaniard's credit-card debt is probably not owed to the company that issued his credit card. That debt is owed to some other financial institution, somewhere else on earth. Where? Who knows?

Even the people who own the debt may not know. As we learned during the subprime mortgage crash, bad loans get sliced and diced, recombined and repackaged, into bonds whose contents are not always understood by the pension funds and insurance companies that buy them. Those bond buyers often only discovered that they had bought bonds based on subprime mortgages after the mortgages failed.

Financial institutions that have bought Spanish credit-card debt (or Spanish mortgages or whatever) may discover equally shockingly late that their bonds also will not and cannot pay off in full.

Think of those potentially redenominated Spanish bonds as toxic admixtures into bond portfolios all over the planet -- including possibly the bond portfolio that supports your pension or your life insurance claim.

And then understand why all this talk of "We could be like Greece" so radically misses the point. We're in the same boat already with the Spaniards and the Italians and, to a much lesser degree, the Greeks -- and not because of the way the U.S. government taxes and spends, but because of the way world financial institutions borrow and lend.

The opinions expressed in this commentary are solely those of David Frum.

ADVERTISEMENT
Part of complete coverage on
July 29, 2014 -- Updated 1650 GMT (0050 HKT)
LZ Granderson says the cyber-standing ovation given to Robyn Lawley, an Australian plus-size model who posted unretouched photos, shows how crazy Americans' notions of beauty have become
July 28, 2014 -- Updated 1156 GMT (1956 HKT)
A crisis like the Gaza conflict or the surge of immigrants can be an opportunity for a lame duck president, writes Julian Zelizer
July 26, 2014 -- Updated 1822 GMT (0222 HKT)
Carol Costello says the league's light punishment sent the message that it didn't consider domestic violence a serious offense
July 28, 2014 -- Updated 1251 GMT (2051 HKT)
Danny Cevallos says saggy pants aren't the kind of fashion statement protected by the First Amendment.
July 28, 2014 -- Updated 1852 GMT (0252 HKT)
Margaret Hoover says some GOP legislators support a state's right to allow same-sex marriage and the right of churches, synagogues and mosques not to perform the sacrament
July 28, 2014 -- Updated 1831 GMT (0231 HKT)
Megan McCracken and Jennifer Moreno say it's unacceptable for states to experiment with new execution procedures without full disclosure
July 28, 2014 -- Updated 1850 GMT (0250 HKT)
Priya Satia says today's drones for bombardment and surveillance have their roots in the deadly history of Western aerial control of the Middle East that began in World War One
July 28, 2014 -- Updated 1635 GMT (0035 HKT)
Jeff Yang says it's great to see the comics make an effort at diversifying the halls of justice
July 26, 2014 -- Updated 1555 GMT (2355 HKT)
Rick Francona says the reported artillery firing from Russian territory is a sign Vladimir Putin has escalated the Ukraine battle
July 27, 2014 -- Updated 1822 GMT (0222 HKT)
Paul Callan says the fact that appeals delay the death penalty doesn't make it an unconstitutional punishment, as one judge ruled
July 24, 2014 -- Updated 2225 GMT (0625 HKT)
Pilot Robert Mark says it's been tough for the airline industry after the plane crashes in Ukraine and Taiwan.
July 25, 2014 -- Updated 1510 GMT (2310 HKT)
Jennifer DeVoe laments efforts to end subsidies that allow working Americans to finally afford health insurance.
July 26, 2014 -- Updated 1533 GMT (2333 HKT)
Ruti Teitel says assigning a costly and humiliating "collective guilt" to Germany after WWI would end up teaching the global community hard lessons about who to blame for war crimes
July 25, 2014 -- Updated 1245 GMT (2045 HKT)
John Sutter responds to criticism of his column on the ethics of eating dog.
July 25, 2014 -- Updated 1302 GMT (2102 HKT)
Frida Ghitis says it's tempting to ignore North Korea's antics as bluster but the cruel regime is dangerous.
July 25, 2014 -- Updated 1850 GMT (0250 HKT)
To the question "Is Putin evil?" Alexander Motyl says he is evil enough for condemnation by people of good will.
July 24, 2014 -- Updated 1803 GMT (0203 HKT)
Laurie Garrett: Poor governance, ignorance, hysteria worsen the Ebola epidemic in Sierra Leone, Guinea, Liberia.
July 24, 2014 -- Updated 1349 GMT (2149 HKT)
Patrick Cronin and Kelley Sayler say the world is seeing nonstate groups such as Ukraine's rebels wielding more power to do harm than ever before
July 23, 2014 -- Updated 2205 GMT (0605 HKT)
Ukraine ambassador Olexander Motsyk places blame for the MH17 tragedy squarely at the door of Russia
July 24, 2014 -- Updated 1142 GMT (1942 HKT)
Mark Kramer says Russia and its proxies have a history of shooting down civilian aircraft, often with few repercussions
July 24, 2014 -- Updated 1853 GMT (0253 HKT)
Les Abend says, with rockets flying over Tel Aviv and missiles shooting down MH17 over Ukraine, a commercial pilot's pre-flight checklist just got much more complicated
July 24, 2014 -- Updated 1317 GMT (2117 HKT)
Mark Kramer says Russia and its proxies have a history of shooting down civilian aircraft, often with few repercussions
July 24, 2014 -- Updated 1637 GMT (0037 HKT)
Gerard Jacobs says grieving families and nations need the comfort of traditional rituals to honor the remains of loved ones, particularly in a mass disaster
July 24, 2014 -- Updated 1413 GMT (2213 HKT)
The idea is difficult to stomach, but John Sutter writes that eating dog is morally equivalent to eating pig, another intelligent animal. If Americans oppose it, they should question their own eating habits as well.
July 23, 2014 -- Updated 1630 GMT (0030 HKT)
Bill van Esveld says under the laws of war, civilians who do not join in the fight are always to be protected. An International Criminal Court could rule on whether Israeli airstrikes and Hamas rocketing are war crimes.
July 23, 2014 -- Updated 1408 GMT (2208 HKT)
Gordon Brown says the kidnapped Nigerian girls have been in captivity for 100 days, but the world has not forgotten them.
ADVERTISEMENT