With the Greek debt crisis, the great experiment of monetary union in Europe is in trouble. A system that got rid of all those colorful paper currencies in Europe and replaced them with new paper notes and tried turning the the euro into a reserve currency to rival the dollar looks like it's going down the chute. Not surprisingly, the Euro has had a hammering and collapsed on Friday after Europe's leaders came out with some strong words but failed to spell out exactly how they were going to pull Greece back from the edge.
So the Greek flu looks like it's spreading through Europe. The question is how contagious is it? How far will it spread?
Some great insights from Charles Wyplosz, professor of International Economics at the Graduate Institute in Geneva. He makes the point that Greece is small beer but the impact of a default could spread as far as the United States. "A debt default by the Greek government, on its own, would be a non-event. Greece is a relatively small country (with 11 million people, its GDP amounts to less than 3% of Eurozone's GDP). Contagion to Portugal, which is even smaller, would also be a non-event. Moving on to Spain and Italy is another matter … The real worry is the banking system. Some European banks hold part of the Greek debt and, if still saddled with unrecognised losses from the subprime crisis, some might become bankrupt. Many governments have simply not pushed their banks to straighten up their accounts, and they are now discovering some of the unforeseen consequences of supervisory forbearance … Contagious debt defaults, along with bank failures, could lead to a double-dip recession in Europe, possibly affecting the US as well. If that were to happen, with the interest rate at the zero lower bound and fiscal policy not available any more, we could face a terribly bad situation."
Economic historian Niall Ferguson says that it could well spread to America. Writing in the Financial Times, he says the problem with debt is that it's the same same from Iceland to Ireland to Britain to the US. It just comes in different sizes. "On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization,'' Ferguson writes. "Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic."
But even if it doesn't engulf the US, it should worry anyone sitting on a loan or applying for one. If fears over big spending governments will spread outside the eurozone, it will infect the credibility of the United States and Japan. If that happens, global bond yields will rise sharply and the price of money will go up. That means the banks will have to pay more to raise money to lend out to their customers. They will lend even less or charge even more.
If that happens, the credit crisis will enter a new and more dangerous phase.
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