European Debt Crisis and Greece

Anyone paying even partial attention to the news the past year has heard about the European Debt Crisis. A few weeks ago, a friend of mine asked me what it was all about and I realized I wasn't really sure. All I knew was Greece had some serious debt issues and the entire crisis has the potential to being even bigger than the US crisis in 2008. As a result, I decided to dig a little deeper into the issue. What will follow is a basic summary of what I understand to be the problem, specifically with Greece.

Greece has received a lot of attention due to concerns it will default on its debt. Greece joined the monetary EU in 2001 and from 2001-2007  enjoyed significant economic growth due to the low interest rates which came with their adoption of the euro. These low interest rates allowed the Greek government to run large deficits to fund social benefits and increasing public sector wages and benefits. Wages and benefits continued to rise well beyond any increase in production which further ballooned the nation's debt as a percentage of GDP, which now sits at 140%+.

The problem is Greece already had too much debt prior to 2001, but was able to conceal its debt level through legal "swap" products, or derivatives, provided by Goldman Sachs. In order to join the monetary union, a member state has to meet certain criterion and if their true debt levels would have been known, they may have never been permitted into the EU. Unfortunately, they were and now the EU, along with the rest of world, are at risk.

In 2009, Greece's true debt levels were revealed and ratings agencies immediately downgraded the Greek debt. As a result, bondholders started selling which caused interest rates on Greek bonds to rise all the way up to the mid 20%'s in mid 2011. This compounds the problem because since Greece is already saddled with debt, it can't afford to pay bond holders at those rates. The 140%+ debt as a % of GDP, rising interest rates on bonds, and unsustainable budget deficits caused Moody's to conclude Greece's chances of default are near 100%.

Why should such a small country's debt problems have such an impact on the world? Greece owes an estimated $300B to other nations and banks. If they default, it would have a sizable impact which would put other nations at risk and jeopardize the financial stability and economic growth of the EU. Greece isn't the only EU member with debt concerns. Spain, Ireland, Italy, and Portugal are facing their own debt and deficit issues. A Greece default could be a falling domino which these nations would be unable to avoid. Since the US relies on the purchasing power of the EU member states, this would certainly impact US growth through a reduction in exports. Additionally, American financial institutions hold EU assets and it is estimated nearly half of money-market funds include EU assets. Since the US economy is barely growing at just above 1%, a Greek default would be a significant blow to US hopes to avoid a double-dip recession..