In chaos theory, the flutter of a butterfly’s wing can ultimately cause a typhoon halfway around the world. This week, Greece, a nation with a GDP smaller than the Philippines, became that butterfly – and its ongoing economic struggles could cause storms that would upend the financial stability of Europe and wreak serious collateral damage on our own economy.
Greece has flirted with sovereign debt default for more than three years. The latest talks for another bailout from the European Union and the IMF broke down this week, with Greek Prime Minister Alexis Tsipras calling the EU proposal “humiliating” and the IMF’s conduct “criminal.” Normally, the debt troubles of a country with an economy barely one percent the size of our own wouldn’t matter much to us. But as a member of the EU and the Eurozone monetary union, Greece’s problems can reverberate deeply throughout Europe. Global investors already are nervous that the EU and IMF may be unable to head off Greece’s looming insolvency.
If the worst happens, Greece’s default could trigger runs on government bond markets in other Eurozone countries seen at risk, including Italy and Spain. Since Europe’s large financial institutions hold more than $1 trillion worth of those bonds, a Greek default could spark a financial meltdown rivalling even the 2008-2009 crisis.
This crisis has unfolded in fits and starts for a long time, and the EU and the European Central Bank (ECB) have spent hundreds of billions of Euros trying to support those bond markets and strengthen the banking system. No one knows if it will be enough to stave off the worst-case scenario. But if a genuine crisis unfolds over the next month or so, everyone does know that European voters will never accept another bank bailout. And if Europe’s economy falls into a tailspin, the ECB will have little room to support and stabilize it by cutting interest rates.
Greece’s default also would trigger its exit from the EU and the Eurozone. No country has ever done so before, so no one knows precisely what would happen next. Inevitably, the consequences would be destructive. To begin, if Greece has to abandon the Euro and revive the drachma, its economy would come to a halt. The government could not pay its employees or vendors, or issue pension checks; and untold thousands of Euro-based contracts today across Greece and between Greek and foreign concerns would have to be renegotiated. So, on top of an unfolding financial crisis, the balance sheets of those foreign firms would suffer further, and a rapidly-deepening recession would spread across much of Europe.
These prospects explain why President Obama made the Greek crisis a top priority in his talks at the recent G-7 summit. The EU is America’s largest trading partner; and perilous times there would quickly affect U.S. jobs and investment – and those costs would increase as the fast-falling value of the Euro would drive up the foreign prices of U.S. exports. Even more serious, our financial institutions and multinational companies have thousands of deals involving European banks.
In a crisis, that becomes bad news for U.S. stocks: If cascading events threaten the solvency of those banks, many of those deals will become problematic, depressing the value of our own banks and companies. The results here at home could be a credit crunch, falling employment, and a new recession – and this time, the Federal Reserve could do little to help.
The United States needs a prosperous Europe for not only the obvious economic reasons, but also as our geopolitical partner from the Middle East to the Korean peninsula and the South China Sea. A weakened Europe, consumed by recession and facing the possible unraveling of a half-century of economic union and political collaboration, won’t be there for us the next time a U.S. president needs support to advance American and Western interests and influence.
What are the odds? A scenario in which everyone loses usually inspires steps to head off the terrible reckoning. Yet, events in coming weeks may demonstrate how domestic politics in Greece and across much of Europe put the two sides at such cross purposes that everyone will needlessly suffer. At this point, calming this butterfly’s wings will require uncommon statesmanship and a real willingness by leaders in Greece, the EU and Washington to take measures that will cost them popular support. So far, we’ve managed to side-step a serious crisis, and we could see another deal that papers over the problems for a while. But if Greece and the EU do run out of options this time, your retirement accounts could lose a third of their value over the next year.