Thursday, April 29, 2010

Why the Greek Debt Crisis Matters

The big global economic news this week is that Standard and Poor's downgraded Greece's debt to junk status, which will make it very difficult for Greece to borrow money.

Some economists say that Greece has entered an economic death spiral and that it's only a matter of time before officials declare insolvency.

Greece is just the tip of the iceberg — or the canary in the coal mine — for the broader sovereign debt problems around the world.

The number of nations with deep debt problems is extensive, as I wrote about recently.

The Greek debt issue has become a European issue, and sooner or later could become a global issue.

As Harvard economist Kenneth Rogoff noted, "This is a very, very delicate situation that could spin out of control."

An eventual Greek default could spark a rapidly spreading contagion, which may have already begun. Portugal and Spain were both downgraded in recent days.

Though the EU has promised bailout money to Greece, it does not want to establish a precedent for bailing out the likes of Portugal, Spain, Italy, Ireland and Iceland, other European nations with burdensome debts.

The debt crisis could spread rapidly if Greece does indeed default.

It was just two weeks ago that the $40 billion EU bailout plan was announced, with the IMF promising additional billions in funding. Greek officials declared victory, saying that they didn't actually need the bailout funds, but that their availability would reassure investors and allow them to continue to borrow on the world markets.

But in the short interim, Greece's fortunes seem to have gone up in flames. This shows how quickly debt problems can become crises, and how quickly crises can become cataclysms.

The Greek bailout is not popular with German voters, who go to the polls next month. As Europe's largest economy, Germany would shoulder the largest proportion of any bailout. This has become a political issue and could sway the election. Germans are leery about bailing out entire nations, having absorbed the much poorer East Germany over the past two decades. German taxpayers are still paying for that huge expense.

The falling euro is a mixed blessing for the dollar, which should also be falling due to high budget deficits and long term US debt problems. The $12.9 trillion national debt is expected to be of 88% of the $14.6 trillion US gross domestic product by year's end.

As bad as the dollar's problems are, relative to other prominent world currencies, it appears stable. That's how bad the global debt problem is.

However, a strengthening dollar will hurt US exports, and since Western Europe receives 20% of US exports, an ongoing financial crisis there will also hurt the US economy.

Greek citizens are taking action in the face of the crisis. In the past two months, they have begun moving their money across the border to safer havens. Some 10 Billion Euros worth of cash and assets have made the exodus to escape a potential collapse.

Some economists think that Greece may have no choice but to leave the euro. And, despite all the repercussions that would ensue, the rest of the 16-nation Euro Zone may gladly let it.

Yet, that could be a cataclysmic moment for the relatively nascent currency.

As billionaire investor George Soros noted, "The consequences of Greece leaving the euro would be the disintegration of the euro. The disintegration of the euro would take [us] a very long way toward the disintegration of the European Union."

That's the ugly possibility European officials are grappling with right now.

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