Europe's four big dilemmas

In October, Europe's leaders reached yet another wide-ranging deal to prevent economic problems from causing financial meltdown in the eurozone.

For many onlookers, the issues they face may seem complicated and interconnected.

But essentially they boil down to four big dilemmas.

How these dilemmas are resolved will decide whether the eurozone stays together, or ultimately unravels despite the latest agreement.

So the question is, how much gets written off, and who picks up the tab? For the eurozone as a whole, the debt problem is comparable with that of the US, and potentially manageable.

The problem is that some eurozone countries are much more heavily indebted than others.

In October's deal some private sector lenders have already agreed to write down the value of Greek debt by half.

Investors also think the Portuguese, Irish, and even the Spanish and Italian governments, may eventually follow suit.

But when bad debts get written off, someone has to take a loss.

While some of those debts are held in the US, UK or elsewhere overseas, most of it is held by the European banks, and increasingly by the European Central Bank (ECB).

This is the primary reason for the recent loss of confidence in the European banking system.

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The October package calls for banks to invest more than 100bn Euros building their capital, but it is not yet clear if they will be able to do so without intervention from governments. If other European countries join Greece in writing off their debts, banks may need even more money. Ultimately Germany and other less-indebted countries may have to bear much of the cost of rescuing the eurozone's banks as well as its weaker governments.

Like everywhere else, most European governments have seen their borrowing balloon during the recession and anaemic recovery.

At the same time, fears over southern European governments' ability to repay their debts mean their borrowing costs have also gone through the roof.

Under pressure from Germany and the ECB, all of these countries have been pushing through painful spending cuts and tax rises.

Rate at which markets are willing to lend to governments for 10 years: Germany: 2.05 percent France: 2.83 percent, Spain: 4.95 percent , Italy: 5.56 percent, Irish Republic: 7.41 percent, Portugal: 10.80 percent , Greece: 22.14 percent To set a good example, Germany has even donned the hairshirt itself, promising to eliminate its own modest deficit by 2013.

But here's the problem: austerity is killing growth throughout Europe.

And with less profits to tax and more dole cheques to write, weak growth makes it even harder for governments to cut their borrowing and repay their debts.

To turn the slowing eurozone economy around, the ECB now looks set to slash interest rates from their current 1.5 percent.

The Central Bank considered buying up more Italian and Spanish debt, pumping cash into the financial system and easing the pressure on those countries to slash their borrowing.But this move has always been strongly opposed by German members of the ECB.

Another option to stimulate growth is for the few other countries that markets are still willing to lend to to borrow and spend more, offsetting spending cuts in southern Europe.

Yet for Germany, who can currently borrow at unprecedentedly cheap interest rates, borrowing is anathema.

Germany’s view on the eurozone crisis is simple.

Southern European governments borrowed recklessly at the cheap interest rates available inside the Euro.

Now they are being punished by markets, and must learn discipline.

Germany wants other governments to incorporate strict budget rules into their constitutions to stop such recklessness in future.

But rules, with penalties attached, may not be credible. Imposing a fine on an over-indebted government is rather like kicking someone when they are down.

Indeed, just such a “stability pact” of budget rules, insisted on by Germany at the Euro’s creation, was quickly broken with impunity by Germany itself.

Moreover, the focus on discipline misses a bigger point. While Germany’s view may be apt for Greece - whose government cheated on its borrowing statistics to qualify for the Euro in the first place - it is grossly unfair for Spain.

Before the financial crisis, Spain’s government had lower debt levels than Germany’s, and (unlike Germany) actually spent less than it earned in taxes. But the country experienced a property bubble that then burst spectacularly, leaving its economy high and dry.

Wages, inflated during the good years, are now uncompetitive, and unemployment has shot up to 20 percent.

Yet, inside the Euro, Spain cannot devalue to regain a price advantage.

Nor can it necessarily expect the ECB to cut interest rates or buy up its debts.

Being put a fiscal straitjacket as well just makes things worse.

Compare this with the US state of Michigan, where the collapse of the US car industry has spelled disaster.

Unlike in Europe, the US has a federal government that can tax other states in order to help out Michigan, by paying for unemployment benefits and rehabilitating the big car companies.

If the Euro is to function in the future, economists warn, then a similar system of centralised fiscal transfers will be needed there too

- BBC