Greece has defaulted on its debt to the IMF and put its financial system into a painful stasis until a July 5 referendum on whether to accept the conditions attached to another tranche of bail-out loans from its creditors.
Why do you care? Contagion, that’s why. The question is: will what’s ailing Greece spread elsewhere?
Mathematically, if Greece winds up not paying all of its loans, economists are pretty convinced that it’s not the end of the world. The equivalent of about 3.3% of Eurozone GDP is tied up in Greek rescue projects, and mostly in government balance sheets, not in private banks. If the country departs the European Union, well, it’s basically been in a recession for the past few years, so that’s only good news for the union, statistics-wise.
“A Greek default does not pose systemic risks to either the euro area or the global economy,” economist Jacob Funk Kirkegaard told US lawmakers (pdf) last week. You’ll hear the word “ring-fenced” bandied around on CNBC—as in, we’ve got Greece ring-fenced, so it’s no problem if it fails.
Except, of course, for the people of Greece, who would be in for some very sharp near-term pain as their financial system collapses, even relative to the five-year depression they’ve undergone as a virtual ward of their European neighbors.
Opinions vary on whether they would be able to recover more quickly without being tied down by the Eurozone’s monetary policy. On the one hand, without an over-valued currency, the tough adjustments the Syriza government has been resisting will be easier to accomplish. On the other hand, the demographics in Greece don’t lend themselves to highly productive future.
But that’s just one kind of contagion. The other kind is harder to predict because it is entirely mental, a nagging question: Is Greece the problem, or is the European Union the problem?
After all, Greece isn’t the only unsustainable debt load in Europe—Portugal and Italy each boast the equivalent of 130% of their GDP in loans—or the largest primary deficit, with France and the United Kingdom in the lead when it comes to spending more than they are collecting in revenue. And Greece isn’t the only country in the region saddled with an aging workforce, and in need of tough labor-market reforms. In Athens, at least, Uber operates freely. In Paris, they’re arresting the local management of the global car-service firm.
If Greece really goes sour, investors may begin to wonder whether the European Union is the problem, and whether other countries that need to outgrow their creditors won’t be able to, either. Will the European Central Bank make good on its commitment to protect the Euro—and Euro deposits—in the next member country to wind up in arrears after Greece leaves? Will there be new procedures to guide economically-troubled countries out of the union?
Question like these presage the most dangerous kind of contagion—the kind where people decide that the world has changed. They haven’t yet, judging by the significant but small reaction in the markets. But Matthew Slaughter, a Dartmouth economist and former White House adviser, says there is a small chance of something comparable to Lehman Brothers, when a relatively small failure suddenly changed the everyone’s assumptions about the way the economy worked.
“No one can plausibly rule out such destabilization in the wake of a Greek default,” Slaughter says. ”Imagine a massive post-default panic to sell the debt of Spain, Portugal, and Italy—and to then buy U.S. Treasuries—that leaves illiquid one of the world’s largest and most-heavily-leveraged hedge funds.”
And the problem with the math around the Greek debt talks is that the costs are so relatively small to Europe, and so large to Greece, that the symbolism will be quite large. As Kirkegaard puts it, “Greece is and will remain solvent if the euro area wants it to be.” If the euro area doesn’t want Greece to be solvent—if they admit they can’t find a political solution for such a small problem—what’s to happen when they encounter a big one?
These troubling questions may not arise. The pain of the bank holiday may unite the Greek populace behind an extension of the Troika’s program, especially if Greece’s creditors demonstrate more willingness to consider debt reduction, something US Treasury officials are pushing for. There are still, after all this, plenty of rational answers available here. But that’s sort of the problem: The more Greek and European officials fail find a rational answer, the more questions global markets will have.