How would the ultimate failure of an European Union member country realistically affect the rest of the union, its currency, and the U.S. markets? It’s a question investors have had on their minds for some time, especially since moves in U.S. markets are taking their cues from Europe.
The most pressing problem is Greece. The latest bailout package offered to Greece by the European Central Bank (ECB) mandates drastic spending cuts. The ECB has emphasized there will be no renegotiation of the terms.
But political turmoil in Greece may make it impossible for the country to fulfill its promises. This could result in Greece finally abandoning the euro and declining into economic and social disaster.
A quick review of how Greece got to this point may help to clarify how a worst-case scenario might affect the rest of Europe and, in turn, the U.S. markets.
André Cabannas, Ph.D., a professor at Stanford University, explains that the Greek government has a long history of spending more than the revenues it receives. Before joining the Eurozone, the government simply would issue more drachmas, its original currency, to make up the difference.
One stipulation of becoming a Eurozone member was that no country could exceed its allowable debt limit. Instead of viewing Eurozone membership as a conduit for greater fiscal responsibility, both government and private entities in Greece saw the euro as an even greater source to tap for its growing deficit.
Large European banks in other member countries were glad to loan Greece money in exchange for the high interest rates Greece agreed to pay. The banks were certain that, if Greece failed to pay back the debt, other Eurozone members would cover it.
Newly flush, Greece began to spend more, not less. For a while, it used a combination of the very goods it imported with its share of euros, its own goods it manufactured, and promissory notes for the balance.
As Greece continued to spend, more of its euros left the country, and it began to have trouble taking care of its internal obligations to its citizens.
Then, the 2008 credit crisis hit. Greece’s resources began to dry up and it was caught with no way to pay its obligations, even on a temporary basis. The rest of the Eurozone became concerned and has debated ever since on how to keep Greece from defaulting and having to leave the union. They fear it would have a domino effect and unravel the Eurozone, along with its common currency.
In an effort to survive, Greece has cut the salaries of its workers, pension payments to its retirees, and has cut back on service provisions to its citizens. The entire political system is in chaos because elections held May 6 were inconclusive. There is not enough agreement on what to do to form a coalition to fulfill the bailout agreement or to abandon it. Failure could come as early as August.
With Greece’s growth rate as measured by gross domestic product slated to decrease by 4.7% in 2012, on top of its 6.9% decrease in 2011, citizens have been running out of money for their daily necessities.
Not all countries agreed to the latest bailout terms. These investors hold €6 billion in Greek debt and the country is contemplating paying off the bonds they hold. Government authorities are in chaos about which direction to take. The lack of direction could result in failure as soon as August. So the probability that Greece will fail is increasing daily.
What would happen then?
Independent economist Fritz Meyer asserts that the inability of Greece to uphold its latest austerity agreement with the European Central Bank would certainly be bad for the country. But it wouldn’t necessarily be bad for Europe, he adds. His prediction is that Greece then would become a stark lesson to other distressed countries, such as Italy, Portugal, and Spain, and make them more determined to avoid Greece’s fate.
If this indeed is the case, markets in Europe and the U.S. would gain more confidence that the crisis was contained. Since Greece no longer would be part of the Eurozone, other member countries would have no obligation to keep up rescue efforts and could, instead, concentrate on their own situations.
Never before has a country left the Eurozone, and there is no guidance for doing so. Moreover, the rest of the Eurozone has its own problems. The European Commission on 11 May 2012 finally admitted the Eurozone is in a recession. It stated that the overall economy will contract by .3% and grow by only 1% in 2013.