Because the Greek economy is tied to the Euro-zone, if Greece goes down it's a very serious problem for the other Euro nations as well.
This is where I got lost. Can somebody explain why the domino effect? I understand that other debtor nations hold some Greek debt, but that doesn't look to be significant enough...
Well...the Greece situation is a horrible state. Damned if you do, damned if you don't. What Greece has done to date is an inordinate amount of spending (financed by cheap Euro loans from banks all over the Euro) - think of what caused the credit crisis in America (people spending money they didn't have - by leveraging their house, etc.).
Ok...well now those loans are coming due, and Greece has further compounded their problem by essentially lying about the state of their finances. Eurostat (an EU watch dog) recently released a report confirming that Greece has essentially been lying about the bad state of it's finances and revised their budget deficit and debt-to-GDP ratio upwards - http://epp.eurostat.ec.europa.eu/portal/page/portal/publicat...
Then, to add insult to injury Standard & Poors recently downgraded Greece's gov't bond ratings to junk status. That basically means that if they wanted to borrow money from the international capital markets, they would pay much higher interest than say Germany. That was expected though, because news was slowly being released that Greece is in a much worse state than they are letting on. The downgrade just 'solidified' it.
Now, in terms of the domino effect, every country in the Eurozone is connected by a number of elements. The eurozone is the largest economic area of cooperation on the planet (geographically). All the countries use the same currency, but not all are controlled by one central bank. Each country has their own individual central bank. But they all share a promise that no one will let any fail, because that invalidates the purpose of the single currency. It would be the equivalent of California going bankrupt. The Federal government will never let that happen, because it would undermine the entire union.
Anyway, so the other countries within the Eurozone that have a similar fiscal profile as Greece are Portugal, Italy, Ireland & Spain (also known as the 'PIIGS'). By similar fiscal profile I mean that whatever happens to Greece, something similar will have to happen to the others. So if Greece is allowed to bankrupt, then investors fear the same thing will happen to the others. If Greece is bailed out, then the same will happen to the others. It really is damned if you do, damned if you don't, because if Greece is bailed out - then they are essentially being 'rewarded' for their profligate spending and 'devious' fiscal behavior over the years. But if they don't bail out Greece, the entire Euro will likely collapse. So they have no choice, assuming they want to preserve the Euro. If they bail out Greece though, moral hazard is created because the other countries are essentially given a guarantee that the Euro authorities (and IMF) will not allow them to go bankrupt either.
All in all, every countries banks have extended loans to (and bought bonds from) companies, governments, and individuals in other countries. So if the debtor defaults, many banks throughout the EU will have an increasing amount of bad loans on their balance sheet - which could force their governments to bail them out (provided the defaults are big enough). Not only that, but credit will dry further and companies that rely on short-term financing for purchasing inventory and paying employees will go out of business because they can't get access to this financing (i.e. the financial crisis will restart). That will then spread to America, the UK, etc.
I know this has been pretty verbose and might be a bit confusing, but I hope that kinda sheds some light on the situation.
Excellent comment, one of the most informative so far ITT. I realize that this borders on fortune-telling, but you seem to have a decent grasp on the situation, and you say RE: bailing out Greece that "it really is damned if you do, damned if you don't", so I'd like to ask -- in your personal opinion, what impact do you see this (the impending collapse of the Euro) having internationally over the coming decade?
In other words, is this necessarily the beginning of a chain reaction, or is there, in your opinion, some route by which the effects of Greece's economic death rattle may be confined locally?
Also, can anyone elaborate on "they all share a promise that no one will let any fail"? Does this 'promise' have a strong legal basis, or is that simply an implied economic obligation in the face of mutually-assured destruction (i.e., as per the California comparison, is leaving Greece out in the cold even an option, legally?)
koanarc....very interesting questions. Due to the clearly increasing interest in this topic, I am going to write a series of blog posts on the crisis (according to what I know - not claiming to be a fortune teller or a sage of any kind, but it seems people are interested).
Well, I wouldn't say the Euro is near collapse just yet. The Obama Administration would never let that happen...i.e. assuming that the Eurozone bigwigs (i.e. Germany, France, etc.) want it to collapse - which I don't see why they would - a collapse of that nature right now would threaten the overall economic recovery. So the powers that be, are doing (and will do) everything in their power to prevent that from happening.
In terms of the impact over the long term, i.e. coming decade, I would say that provided that the Euro can get through this it should prove good for the EU. Because the only way they are going to get through it, is if the EU + IMF bailout the problem states. We have already seen the major sacrifices that have been demanded of Greece as a condition for getting the bailout - http://news.bbc.co.uk/1/hi/8656649.stm
Although Greeks might be pissed at the 'financiers' for imposing 'harsh' conditions to the bailout, in the long term it will be healthy for Greece. They have to go through a bitter, deep, cleansing period (kind of like the bankruptcy proceeding that GM had to go through to get out of their onerous contracts they had with labor unions & dealer network) to get to a more healthy fiscal position. Unless I am mistaking the resilience of the politicians to weather the storm, I strongly suspect that they will persevere through the political maelstrom and do what needs to be done. Then in 5 - 10 years, we could see some strong growth coming from Greece again - however it all depends on what policies (aside from the austerity measures) they implement.
By bailing out Greece and demanding significant austerity measures, they are attempting to contain it locally. The issue is that if they don't take their pound of flesh, the other states/countries will expect the same. So to nip the moral hazard element of it, they (the EU & the IMF) have to be harsh. It's for everybody's own good.
In terms of the strong legal basis...I will cover this in my blog post. I believe there is some legal basis for it - but I am drawing a blank right now. I am going to do some research and include it in my post. Stay tuned, will post on HN once I am done. At the very least, even if there isn't an explicit legal basis for the bailouts, there is a strong implied economic obligation - because it is in everybody's best interest to bail out the weakest state. Just like it was in America's best interest to bail out the banks - as annoying as it was to do, with them paying record profits - the alternative would be significantly worse. Emphasis on significantly.
Hm. I am certainly no economist, but I'm still not 100% sure that I have any logical reason to agree that "it should prove good for the EU" for the EU+IMF to "bailout the problem states", or even that "it was in America's best interest to bail out the banks"...
You say that "by bailing out Greece and demanding significant austerity measures, they are attempting to contain it locally", but doesn't the process of a group of nations bailing out a member nation (or, likewise, any multinational corporation), by definition, extend the problem beyond local/intra-national economics? Especially when a currency is shared among many disparate nations? What happens if/when a nation such as Greece decides that adhering to the Euro is more trouble than it is worth?
The idea of a "a bitter, deep, cleansing period" I can get on board with -- most nations seem to be due for a fundamental economic/structural revaluation -- but like you said, not bailing out Greece could have dire 'domino' consequences, and doesn't leave much of a choice. But then, when Greece is bailed out, a nasty precedent is set, and what reputation/value will the Euro have when Spain or Portugal inevitably start to experience these very same issues?
So, I guess I return to my original question: is it at all possible for Greece to play the "tank" and absorb most of the serious economic fallout from the present situation, or are the Greeks the canary in the global coal mine? Or am I presenting a false dichotomy?
Also, you suggest in another comment that printing their own money would be a worse scenario for Greece -- why? Many countries do so, and I'd suggest that most of those countries have "profligate governments", but as far as I can tell aren't facing these obstacles to quite the same extent.
Among Greeks at least, there's a significant feeling that Greece won't come out ahead, and that these measures are being imposed for the benefit of: 1. other EU countries; and 2. bond investors, some of whom are the same as #1 (e.g. a bunch of German banks). May or may not be true, but there's a large sentiment (maybe even a majority) that the average Greek, especially those in, say, the bottom 75% of wealth/income, would be better off if the government just defaulted on the bonds. They point to Argentina, among others, as a successful example of taking that route.
Hah! I am glad you pointed out Argentina as an 'example' of 'a successful example'. I will definitely cover this in my blog post.
This recent crisis has shown that Argentina never did recover from that initial default and has had to default a second time. Talk about going back to the well!
The "going back to the well" I think might actually be part of it: a lot of Greeks consider that a perfectly viable option, because they remember a past of periodic defaults / currency devaluations every 10 to 20 years or so (and remember Italy doing the same), and don't remember it being particularly bad. Probably a significant proportion would rather go back to that, even if it meant pulling out of the Eurozone, than enact neoliberal reform.
Well...the thing is, back in the day it probably was bad - but not as bad as it would be today. Today, everything is so interconnected. Society has progressed so much, and wealth has been generated at such a fast clip, that cutting off your nose would do nothing but spiting your face.
The reality is that when you look at what has been powering Greece's astounding growth from 1996 - 2006, it was mainly tourism + foreign direct investment.
If you do an Argentina-type default, tourism will instantly be hit and FDI will go to nearly zero (or very close) VERY quickly. The unfortunate truth is that pulling out of the Eurozone wouldn't be a cure all. Without the discipline being forced on the politicians by the EU + IMF, what will force them to change and be fiscally prudent? Nothing will. If anything, things would only get worse because they would be able to print their own money again.
You know what happens when a profligate government can print their own money? Ask Zimbabwe.
The 1996-2006 growth is actually part of the disagreement as well: a lot of Greeks feel ambivalent at best about it, because they feel it went disproportionately to a relatively small elite (I don't have the numbers on whether that's true). Total GDP went up significantly from 1996 to 2006, but the feeling is that it went mainly to the top 25%, with a good portion going to the top 10%. I believe (though I'd have to look it up) that real income of the bottom 50% was flat or declining over that period, which would mean that fully half the country doesn't perceive 1996-2006 as a positive economic period at all.
On the inflationary side, Zimbabwe is an obvious example (with Weimar Germany) of the levels you don't want to go to, but the 1970s Italian/Greek levels of circa 30% annual inflation (with a sort of punctuated equilibrium yearly distribution, i.e. 5-10% most years and 1000% once a decade) aren't quite the same as circa 30,000% annual inflation. It has a lot of effects, some negative, some positive, but is a different sort of beast.
I read a few days back that the European Central Bank also owns a lot of Greek bonds. So it might have a big impact on the financial institutions in the EU.
Well...that's not really what this whole crisis is about. The deal with the European Central Bank (ECB) and Greek Bonds is that, basically the ECB is the bank of last resort to European banks. European banks can borrow from the ECB, but they have to post collateral for the loans. Kinda like when you go to buy a house, you have to put down 20% or 30%. Or if you are getting some other loan you have to put some security (like the title of a house or car) to 'secure' the loan. Well, the banks have to do the same thing.
The issue with Greek bonds is that the ECB requires the collateral for the assets that banks are allowed to use, to have a certain rating level or above.
So, basically the ECB knew that Greek bonds were in jeopardy, and in an effort to continue accepting them as collateral from the banks they had to relax their standards. Basically saying you can give us crap in exchange for cash, rather than giving us gold for cash.
This is where I got lost. Can somebody explain why the domino effect? I understand that other debtor nations hold some Greek debt, but that doesn't look to be significant enough...