Europe just dodged a bullet, for the minute. Greece will not default, at least not this month. Yesterday the IMF agreed to release €12bn, which is enough allow Greece to pay off all its bonds maturing in July. The streets of Athens may be filled with rioters, the Greek government may be teetering, but the bondholders will get paid and that means Europe’s financial system has staved off disaster. But the crisis has not been averted, merely delayed. And that crisis could spread.
The Greek economy is tiny, less than 2 per cent of European GDP. It goes under and the rest of the world yawns. But, should Greece default on its debts, private investors will then flee Portuguese, Irish, Spanish, and perhaps Italian bonds. It is contagion that gives finance ministers sleepless nights. Banks all over the continent, their balance sheets loaded with PIIGS (Portugal, Ireland, Italy, Greece, Spain) debt, could go under. And if their governments do not bail them out, then ATMs go dry and ordinary citizens could lose the money they have in their savings accounts. The European economy would contract, trade would evaporate, unemployment would skyrocket, all of Europe would suffer like it hasn’t in living memory.
Sensible people understand these dangers and that gives us hope that the IMF and the European Central Bank will find a way to keep tossing money at Greece and so avoid anything that smells like default. But unfortunately, sensible people do not control the world.
German taxpayers naturally resent having to bail out their lazy and spendthrift southern neighbours. They ask themselves, why should they throw good money after bad? Greek workers naturally resent the tax hikes and wage cuts demanded by the IMF. They ask themselves why should they suffer just to pay off foreign creditors? Private sector investors are terrified of being locked into a losing position, if liquidity evaporates and everybody wants to sell PIIGS debt and nobody wants to buy. They figure maybe better get out sooner rather than later.
Extrapolating from the price of credit default swaps, the market expects a 75 per cent chance of Greek default sometime in the next five years. Here is the nightmare. The Greeks, knowing the Germans need to bail out Greece more…