Why is Greece such a big deal?
@thekarenforeman tweeted me today, asking if I could explain why Greece is so important to the world economy.
A good question, to which people have given a wide variety of answers. On the one hand, some people reckon Greece should be cut loose and allowed to default. At the opposite end of the spectrum are those who say a Greek bankruptcy represents an enormous risk, as it could bring the global financial system to a grinding halt.
CNBC’s Net Net has a good (if horribly slow and clunky) step-by-step description of how this apocalypse might play out, although it is a bit technical.
It’s a bit like the Lehman Brothers nightmare played out on a larger scale, in that it’s not really Greece that’s the problem: it’s the people that have done business with Greece.
Lots of governments and banks have lent the Greeks lots of money. The fear is that if the Greeks default on their sovereign debt, then all the country’s banks will go bust, and suddenly much or all of the money that they owe will simply disappear.
Suddenly, we’ll have banks, including central banks like the ECB and the US Treasury, with huge holes in their balance sheets.
We’ll get back to the ECB in a second, and focus on regular banks for now. Banks lend money to each other all the time - that’s how the financial system works. But no-one knows exactly who lent money to the Greeks, or how much. Banks will be looking at the people they usually lent to - their counterparties - wondering how big those holes are, and where they are, and whether their counterparties will be able to pay their debts.
That uncertainty will freeze lending - why would you lend to someone if you’re worried she might not pay you back? - and that won’t just affect banks. Lending rates to companies will soar, if not dry up altogether.
Then there’s the matter of insurance. A lot of banks bought insurance, called CDS, against a Greek default, which means a default will trigger some big payouts. No-one knows how big, or which banks will be paying. Which means even more uncertainty.
Next there’s the PIIGS problem. Italy and Spain may be a little further out of the woods, but Portugal and Ireland are still in pretty dire straits: they also owe lots of money to lots of people. And there’s a danger that if they see Greece default, they”ll be tempted to do the same thing. If that happens, we’ll have Greece x3.
Finally there’s the European Central Bank, which has lent serious amounts of euros to Greece and Ireland. The ECB won’t go bust, but in order to fill the hole, it may decide to print more euros, which could mean massive inflation in Europe, as those euros will be worth a lot less.
Watching this horror story play out across the Atlantic, American investors will almost certainly become more conservative. They’ll spend less, invest less, and build less. That’ll put the brakes on our already struggling economy.
And leave us all very badly needing a drink.
