Contagion. It’s the dirty pill that keeps Europe awake at night. Undoubtedly, if Greece falls, contagion will occur, causing severe panic in the international markets, but even more concerning, possibly swelling into a tsunami that can truly cause a world recession similar to pre-World War I levels. The scenario is simple, if the Greeks opt not to accept any austerity measures, any IMF assistance, debt restructuring plan or any type of European bailout, then Greece’s economy will crumble. As a result, contagion will transpire, meaning Portugal, Ireland, possibly Spain, but most certainly Italy would be next in line in following Greece’s chaotic odyssey.
It’s alarming that Greece, a country that contributes 2% to Europe’s GDP, can trigger an economic nightmare that risks the stability and legitimacy of the European Union. As a result, the stakes are too high to even allow Spain or Italy to be compared to Greece, reason being is that Spain is a much larger participant in the European Union’s economy, where as recently as 2003 it was considered by economists and pundits the 8th strongest economy in the world, surpassing Italy. That’s no longer the case. The Italians have their own problems. Currently, Italy is the third-largest economy in the European Union, and the world’s third biggest issuer of government bonds. Italy relies heavily on the bond markets to operate daily governmental obligations. If Italy became the next focal point in Europe’s troubled economies, in an instant it would be on its knees because interest rates on the bonds would rise, making it more expensive for Italy to borrow money, creating more difficulties to the heavy burden of already shouldering a debt to GDP ratio of 120%—a worrisome statistic.
In 2008, contagion became a reality in the U.S. The Federal Reserve decided not to save Lehman Brothers, which soon exposed the vulnerability of other companies such as AIG, Bank of America, Citigroup, Morgan Stanley, Merrill Lynch, etc. Many companies closely flirted with the same fate; luckily government intervention prevented economic Armageddon. Nevertheless, the ramifications of Lehman Brothers’ collapse sank the stock market which trickled down to causing investor and consumer panic, stifling the economy into a recession the U.S. still has not fully recovered from.
In the U.S., the culprits were rating agencies, private and investment banks and insurance companies. In Europe, the crisis is obviously different; nation states are the main actors, where the core matter is sovereign-debt. Companies and banks come and go; it’s the nature of capitalism. Nation states are who they are, they don’t have the luxury of changing their name or merging with another country, it’s much more complicated. Hence, the crisis in Greece is pivotal, and if Greece’s economy caves in, the forecast of contagion will ultimately plant all of Europe into an economic frenzy.
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The Realities of Financial Contagion
July 22, 2011
Contagion. It’s the dirty pill that keeps Europe awake at night. Undoubtedly, if Greece falls, contagion will occur, causing severe panic in the international markets, but even more concerning, possibly swelling into a tsunami that can truly cause a world recession similar to pre-World War I levels. The scenario is simple, if the Greeks opt not to accept any austerity measures, any IMF assistance, debt restructuring plan or any type of European bailout, then Greece’s economy will crumble. As a result, contagion will transpire, meaning Portugal, Ireland, possibly Spain, but most certainly Italy would be next in line in following Greece’s chaotic odyssey.
It’s alarming that Greece, a country that contributes 2% to Europe’s GDP, can trigger an economic nightmare that risks the stability and legitimacy of the European Union. As a result, the stakes are too high to even allow Spain or Italy to be compared to Greece, reason being is that Spain is a much larger participant in the European Union’s economy, where as recently as 2003 it was considered by economists and pundits the 8th strongest economy in the world, surpassing Italy. That’s no longer the case. The Italians have their own problems. Currently, Italy is the third-largest economy in the European Union, and the world’s third biggest issuer of government bonds. Italy relies heavily on the bond markets to operate daily governmental obligations. If Italy became the next focal point in Europe’s troubled economies, in an instant it would be on its knees because interest rates on the bonds would rise, making it more expensive for Italy to borrow money, creating more difficulties to the heavy burden of already shouldering a debt to GDP ratio of 120%—a worrisome statistic.
In 2008, contagion became a reality in the U.S. The Federal Reserve decided not to save Lehman Brothers, which soon exposed the vulnerability of other companies such as AIG, Bank of America, Citigroup, Morgan Stanley, Merrill Lynch, etc. Many companies closely flirted with the same fate; luckily government intervention prevented economic Armageddon. Nevertheless, the ramifications of Lehman Brothers’ collapse sank the stock market which trickled down to causing investor and consumer panic, stifling the economy into a recession the U.S. still has not fully recovered from.
In the U.S., the culprits were rating agencies, private and investment banks and insurance companies. In Europe, the crisis is obviously different; nation states are the main actors, where the core matter is sovereign-debt. Companies and banks come and go; it’s the nature of capitalism. Nation states are who they are, they don’t have the luxury of changing their name or merging with another country, it’s much more complicated. Hence, the crisis in Greece is pivotal, and if Greece’s economy caves in, the forecast of contagion will ultimately plant all of Europe into an economic frenzy.
