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Greek tragedy for the world economy

Ideas@TheCentre – The CIS newsletter (Sydney), 11 December 2009

Just when many thought the global financial crisis was over, it re-emerges with a bang. This week, Greece and Spain both had their credit ratings downgraded. Standard & Poor’s changed Spain’s outlook from ‘stable’ to ‘negative.’ For Greece, the news was even worse: Fitch revalued Greece’s creditworthiness to BBB+, just a few steps above junk status.

Dramatic as these developments sound, they are hardly surprising. When Greece was allowed to join Europe’s Monetary Union in 2002, it benefitted enormously from the Eurozone’s lower interest rates. Unfortunately, the Greeks did not use this opportunity to consolidate their finances. Instead, they took it as an invitation to run even higher deficits.

Only in one year, 2006, was Greece able to comply with the EU Growth and Stability Pact, which sets a budget deficit limit of 3% of GDP. Following the financial crisis, this deficit has now ballooned to 12.7%. At 121% of GDP, Greece’s public debt is much larger than its economy, making it the most indebted country in the European Union.

Australians could be forgiven for thinking that Greece’s problems are those of a small, faraway country. But they matter for at least two reasons. First, the GFC has demonstrated how interconnected the world economy has become. There are no faraway places anymore. Second, the Greek troubles could be a harbinger of much worse. It is only a matter of time before one of the world’s other sovereign debt time-bombs detonates.

That even Greece could trigger a financial domino effect is not least due to its membership of the Euro currency. There is no political way the other Euro member states could let the Greeks go under. Having just supported their banks, French and German taxpayers may now have to bail out a whole country. This will have implications for the Euro and economic stability, generally. It could even break the European Union with unforeseeable consequences.

Whether Greece will be the next country to declare bankruptcy is by no means certain. Other hot contenders are the Baltic states, Spain, Dubai, Ireland and, threatening even greater disruption, Japan and Britain. US public finances hardly look reassuring, either.

There is a real possibility that some countries have overstretched themselves so much that they cannot service their debt in the near future. It now looks more like a question of ‘when’ rather than ‘if’ that will happen. We are anxiously awaiting the next act of this Greek tragedy.

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