Why the Crisis in Greece Matters to You
06/01/2010 - The deteriorating economic situation in Greece is largely responsible for the recent selloff in global markets. Markets worldwide are paying close attention to economic conditions in Europe, and Wall Street is reacting to the televised images of riots and protests as Greece attempts to stabilize its situation.
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So it's no surprise that skittish markets plunged upon the latest developments in Europe. World markets have been concerned about the state of some unstable European economies – namely Greece, Spain, Portugal, Italy, and Ireland – whose national debts continue to hamper their full participation in the global recovery. Here is a summary of the situation and a few things to watch as it unfolds in the coming days and weeks.
Why is Greece in crisis?
After years of deficit spending and continued borrowing with no significant success in raising revenues, the Greek economy was in a precarious position when the economic downturn hit during 2008-2009. Its national debt now outpaces its gross domestic product (GDP) by more than 12 percent.
Greece's debt recently downgraded to junk status, which indicates that foreign investors have little confidence in the strength of the Greek economy. Pension funds and other investors are unable—except at prohibitively expensive distressed interest rates—to buy the country's bonds, eliminating a key source of funding for Greece. The prime minister is attempting to address the crisis by implementing tax increases and steep, unpopular spending cuts – leading to civil unrest and riots.
Many citizens took to the streets to protest increased consumer taxes, cuts to pension funds and wage freezes on civil servants. Greece also proposed eliminating some public sector positions, and has asked public employees in the military, police, hospitals and schools not to retire, as it would place additional demand on public pension resources.
What is being done to improve the situation?
European Union (EU) leaders worked with the International Monetary Fund to structure a solution and act quickly. The EU announced a bailout package on May 9 measuring nearly $1 trillion total in an effort to stabilize the situation and bolster confidence among investors. This speedy, unified, and bold reaction came after the European nations had taken earlier criticism for being tentative when early signs of the crisis appeared.
In addition, the central banks of Canada, Britain, and Switzerland, together with the U.S. Federal Reserve and the European Central Bank, moved to establish swap lines that are expected to provide more liquidity to the European banks and money markets. These moves indicate that the crisis is being monitored – in Europe as well as in North America – to keep the situation from spreading to other debt-ridden economies.
What does it mean to consumers?
The crisis has hit euro-dominated companies hard, so investments in firms or pensions with significant exposure to these companies have suffered. On a broader perspective, this episode has hurt the credibility of the euro, and its value compared to the U.S. dollar has fallen. In the near term, American travelers will see their dollars go further when they travel to Europe. Conversely, European traveler to the U.S. will realize less buying power out of their euros.
What is the outlook for Greece and the EU?
Markets will be watching the developments in Europe closely in the near future to see if fears of the debt crisis in Greece spreading to other debt-saddled countries. Greek debt to European banks totals around $200 billion; if the crisis extends to Spain and its $800 billion bank exposure, the situation will be seen as more serious.
What about the U.S. deficit?
This crisis has spawned a new sense of urgency in discussing the growing deficits in other countries, including the U.S. (whose deficit reached $1.4 trillion in 2009). However, the U.S. economy is diverse and robust, towering over that of Greece, which is small and getting smaller. Although the U.S. economy is now growing again, markets are paying closer attention to the U.S. federal deficit. The crisis in Greece has leaders around the world taking notice, and its tale of unchecked deficit spending should serve as a warning for us all. Nations that take significant steps to rein in deficits will provide a more solid footing for their economies, and in the process will show investors that the recovery we have seen since the market lows in March 2009 can continue, even with periodic corrections.
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