WASHINGTON (CBSDC) — Greece is days away from running out of cash after voters rejected a referendum Sunday that creditors proposed in exchange for loans for the European nation.

Even though the crisis is a half-a-world away, the financial fallout can still do damage to the economy in the United States.

CBSDC spoke to Erik Jones — a Professor of European Studies and International Political Economy and Director of European and Eurasian Studies at the Paul H. Nitze School of Advanced International Studies (SAIS) of the Johns Hopkins University — about the Greek debt crisis and the affect it can have here.

_______________________________________________________________________

CBSDC: Why should Americans be concerned about the Greece debt crisis?

JONES: The crisis in Greece is important because it will have a big impact on the European economy as a whole. That may seem hard to understand given that Greece is so small relative to the rest of Europe.

The problems in Puerto Rico are not going to define how things work in the United States, for example. This is where the differences between Europe and the United States become important.

What holds the United States together is a strong political commitment. What holds Europe together are a set of different agreements – some strong, some weak – for national governments to cooperate. One of those agreements is for European countries to share a common currency, the euro. This has to be a strong agreement in order to work. If it turns out to be a weak agreement, then it makes sense to move your euros from poorer parts of Europe to richer parts of Europe so that they can be invested safely.

Unfortunately, by doing so investors make the poorer countries even poorer. That is why the European Central Bank promised to do whatever it takes to safeguard the euro as a common currency. That was an important part of shoring up the euro as a strong commitment.

If Greece leaves, then it will be clear that the commitment is weaker than Europe’s political leaders had promised. Investors will react accordingly by moving their money from poor countries to rich countries and so make likely that other governments will have to follow Greece. This will do a huge amount of damage to the European economy. Since Europe is one of the United States’ most important trading and investment partners, it will do huge damage to the U.S. economy as well.

CBSDC: How will the Greece debt crisis affect the American economy and the average American investor?

JONES: The impact of the Greek debt crisis is already being felt in terms of the relative weakness of the euro relative to the dollar.

Of course Greece is not the only reason that the euro has lost value, but it is an important one. It will become more important if this crisis in Greece continues to worsen. The result will be to lower the volume of exports from the United States to Europe. That will hurt U.S. manufacturing. It will also lower the value of existing investments made by American financial firms in the European economy.

This could have an impact not only on firms that work on both sides of the Atlantic but also on pensions and insurance companies with large and diversified asset portfolios.

CBSDC: Why is Greece’s economy in such shambles?

JONES: There are a number of longer term answers to this question that relate to government finances, market structures, and productivity.

Greece would have been better off if it had a more responsible government, more flexible markets, and more productive workers. But that doesn’t mean that Greece would have been OK. Ireland had all those and still got into trouble.

The reason was that when the financial crisis hit, investors worried that the euro would not hold together and so they moved their money out of Greece (and Ireland) and into countries they thought would be safer like Germany.

If you take all the money out of a national economy, you should not be surprised if the firms stop doing business and the banks start to fail.

The fact that Greece had bad government finances, poor market institutions, and low productivity did not cause this problem. But this combination of factors did make it harder for Greece to recover. This is what we are talking about a Greek crisis and not an Irish crisis. They started in the same place and for much the same reason but they ended up very differently.

CBSDC: We hear about austerity when reading about Greece’s economy. To the person who might not know what that is, how would you explain what austerity is and how does it relate to the crisis?

JONES: The Greek government has done more to cut spending and to raise taxes than just about any government in history. It probably needed to make that effort given the state of its public finances.

The question is whether it should have tried to all of that so quickly and at a time when the economy was already suffering. The answer is that it should not have. Greece has a pretty closed economy. A lot of the demand for Greek output comes from the Greeks themselves. Households and firms were already cutting back; fiscal austerity meant that the government was pushing in the same direction. It is no surprise therefore that the Greek economy went from bad to worse under this policy.

CBSDC: Can the U.S. step in to help Greece, or is this simply a European issue?

JONES: The United States has already stepped in through its participation in the International Monetary Fund (IMF).

The IMF has loaned Greece more money than any other country in history. Unfortunately, those loans were not enough to solve the problem and the policy advise that came with them succeeded in making the problem worse.

As a result, the situation has only deteriorated. All along the Obama Administration has been warning its European allies that this is a possibility. The Europeans have responded that they will keep their own house in order.

That is probably this most the U.S. Administration can be expected to accomplish. If your friends and allies do not want your advice, you cannot force them to take it. That said, the IMF clearly regrets much of what has happened and has recently argued that the Europeans have to offer more debt relief for Greece in order to find a lasting solution.

CBSDC: Will this lead to another global financial crisis?

JONES: This is not another Lehman Brothers moment. The Europeans have a number of firewalls in place to prevent the Greek situation from spreading immediately.

The question is whether and how long those firewalls can contain the problem. If the Europeans can come to some sort of agreement, this could all blow over – not quickly, but eventually.

If they do not come to an agreement, it could smolder away like a root fire. Anyone who has ever been camping knows that root fires are exceptionally dangerous because they spread with no-one noticing until it is too late.

The worry is that the Greek crisis could spread below the ground only to come up later in dramatic fashion.
_______________________________________________________________________

Read Jones’ latest blog post: Europe’s Political Economy Does Not Have to Be Tragic.

Comments

Leave a Reply