debt, greece, crisisI have read many articles in the media that state that possibility of Greek default threatens all euro-based economies and existence of the euro monetary union as a whole. They however never explain why. So my question is exactly this - suppose, Greece defaults, partially or completely, on its debts. I understand many Greek bondholders will be hurt - in whatever country they reside. But I seriously doubt whole euro economy is based on lending to Greece - whole Greece economy is mere 2.5% of eurozone. Is there another problem with this for every country that also uses euro and if so, what this problem is? Greece, as far as I understand, has no control over ECB policies and borrowing rates for the are market-based, so why would France, for example, care if nobody lends to Greece anymore and Greek economy collapses? Except for the usual problems with having collapsed country nearby (immigration, public order & safety, etc.) is there any direct economic consequences that would follow? I keep reading that this would “undermine confidence in euro” but I don’t understand what that means - Greek debt is one thing and French one is another and German yet another, even if they are denominated in the same currency, why Greece defaulting would undermine confidence in Germany?
Could anybody explain the mechanism of the consequences that could follow for other euro countries if any euro country defaults on its debt?
It may not threaten the Eurozone but it definitely threatens European banks - particularly French and German banks that hold a lot of the Greek debt.
If the Greek government defaults on their bonds then the French and German banks must write down their losses for the Greek bonds they own. If those losses are substantial then these banks may have to sell other assets - French and German bonds - to cover their losses. This would drive up interest rates which would make it more expensive for the French and German governments to borrow. This would make it more difficult for these governments to borrow as it becomes more expensive to borrow.
In effect, hardly any western government can tolerate rising interest rates since most of them already have a massive amount of debt. A Greek default could just be the domino that triggers the start of default on government bonds.
How would a Greek default affect the Euro? It depends on how the European Central Bank (ECB) reacts? If the ECB allows Greece to default without printing money to bail them out then the euro will survive. If the printing press is chosen as the solution then the euro will meet the fate of many other government fiat currencies that were printed into oblivion.
Greece is a part of the EU and is supposed to meet certain criteria. One of those criteria is that they not default on their debt. The EU is also supposed to help keep the economy of its member nations stable. But the EU Constitution was never ratified so the only thing holding the EU together is the Treaties that say they agree to follow the rules set forth. Because the constitution was never ratified there is teeth behind it.
Those people investing on Greek debt today are speculating that either Greece will do something to right its ship, or that the EU will come along and bail them out. Should the EU not bail out Greece and it is allowed to default and would eventually be severed from the union(unless it figures out how to right its ship in default on its own... I will cover bets for those who think that is possible) then a precedence is set. But there are several other countries that are not in as bad of shape as Greece primarily because the EU backs them. The faith in their bonds would plummet. Their credit would cost more and thus pushing them towards the state that Greece is in now. Those countries that have would be inclined to pull away from those that do not to keep from being pulled down with them. Assuming that Greece, Italy, and Spain are allowed to default, Germany pulls out rather than support so now the EU has lost its financially strongest member, Great Britain is already only a member in name and would probably pull out to save themselves. The Euro would collapse as there is no country really backing it that can support itself let alone those once above marginal countries that have been drug down trying to save the rest...
This is only speculation of what would happen but it is what quite a few fear... probably rightly so. Without the Euro the Chinese could take economic actions to devalue the dollar leaving them the only solid currency. China does not have a history of being light footed with its power.
** update - in the comments it was mentioned that no one was saying that... now several months later it is being pointed out by several big names including...
Soros warns euro crisis could destroy the EU
"The euro is undermining the political cohesion of the European Union, and if it continues like that could even destroy the European Union," Soros said. "That is due to a misunderstanding of what the problem is."
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