ET in the Classroom: What the Greek crisis means to the world

Why Does the World Want to Save Greece?

No one can quantify the damage to the world if Greece is allowed to sink. But few are willing to risk it either. Such a fear owes its origin to the 2008 crisis. Many economists, policymakers and some within central banks believe that the financial meltdown of 2008 could have been ringfenced, or at least cushioned, if Lehman was bailed out. But since Lehman was an investment bank, and not a commercial bank holding savings of millions, Fed and the US government had thought that the collateral damage from its bankruptcy would be contained within a few blocks of Wall Street, and no one really would lose jobs and take pay cuts. Within months we all found out how wrong they were. Today, no one wants to take a chance with Greece. Leaders across Europe fear that a Greece collapse can start a fire that will engulf continents.

How does fear spread when markets are in such a state?

Banks impacted by a default may find themselves cut out from the dollar market — the engine of global liquidity. As a result, these banks will find it very difficult to roll over their dollar assets as the other banks which are more solvent would be unwilling to lend them. That’s when the world outside financial markets would feel the pinch. Suppose, a French bank that had given a dollar line to the European subsidiary of an Asian company, or to bank in Asia which, in turn, had extended a dollar credit to a local company, would not roll over the credit line

Will a default cause a dollar scarcity?

Banks and companies are already holding on to the dollar. A default will only deepen it. Consider the Asian company whose dollar line has been pulled bank. It will somehow try to organise the money by paying a premium. Having sensed a dollar scarcity and fearing that things may turn worse, it will raise more than it needs. When all companies start doing it, there is artificial scarcity. Not just banks, corporates in Greece would also default

How will panic boil over to other Euro nations

Speculators will target Portugal, and then Italy. The logic is simple: if Germany & ECB do not help Greece, they will also let Portugal and Italy sink. Soon these will be perceived as basket cases and their bonds, stocks and currencies will face a brutal attack from short-sellers. That would be a problem as Italy’s debt is more than the combined debt of Portugal, Spain and Ireland

So, time’s running out for Greece?

Close to $8 billion worth Greek bonds will mature in December. It needs the money before that, failing which a default is inevitable. IMF is willing to lend a little over $8 billion, but only if Greece takes a string of austerity measures. IMF is not spelling out exactly when it will sanction the loan. Some economists fear the IMF pressure can make things difficult for Greece: how will lower consumption help a country which is already doldrums

Isn’t Germany in a bit of a Catch-22 situation

It is. German politicians know that if there was no euro, its currency would have gained so much that their exporters would have been wiped out. It needs the euro. But convincing Germans isn’t easy. They don’t want to bail out all Europeans, particularly those who don’t work hard. Some think Greece should be exiled from EU for a few years to should put their house in order