European leaders add to rising fears of breakup
From
http://economywatch.msnbc.msn.com/_news/2012/05/17/11744794-european-leaders-add-to-rising-fears-of-breakup?lite msnbc.com
By John W. Schoen, Senior Producer
European officials are playing a
dangerous game of chicken with Greece.
In an apparent signal to Greek
voters, the head of the World Bank warned Thursday that if Athens were to
depart from the common currency, Spain and Italy could well be the next
dominoes to fall in Europe’s widening financial crisis.
After ousting the Athens government
that agreed to deeper spending cuts in return for a financial lifeline, voters
return to the polls in June after the winning parties failed to form a new
government. Apparently hoping to convince Greek voters to return a
pro-austerity government to power, European officials are now openly discussing
the likely dire consequences if they don’t.
But the comments may have only
served to heighten fears of a wider breakup of the eurozone should Greece exit
the monetary union.
Investors backed away further from
Spain's government debt Thursday, raising the country’s borrowing costs to
levels that sparked the Greek debt crisis in the first place.
Bond buyers were also reacting to
fresh economic data showing that Spain’s economy is beginning to shrink, which
makes its existing debt load even harder to carry.
The growing crisis also has caused
growing nervousness among U.S. investors. Since the inconclusive Greek vote May
6, the Dow Jones industrial average has fallen in seven out of eight sessions
and was down again Thursday. U.S. banking giant JPMorgan Chase send another
ripple of worries through the market May 10 when it said it had lost at least
$2 billion in a failed attempt to hedge against European volatility.
The recession is also putting more
pressure on Spain’s banks, which have been saddled with bad mortgages as the
country faces a deepening housing bust. Last week, the government took over
Bankia, which holds 10 percent of the banking system’s deposits, after it
reportedly suffered an large outflow of deposits.
The news follows reports that
depositors pulled another $900 million out of Greek banks on Wednesday,
extending a capital flight that could bring down Greece’s banking system. The
fear is that those worries spread among depositors in other countries like
Spain where the banking system is already under pressure.
Until very recently, European
officials were loath to even discuss the idea of Greece’s departure from the
compact binding 17 nations with a common currency. For one thing, the treaty
that created the euro has no provision for a member country to abandon the
currency or for its expulsion by the rest of the monetary union.
But central bankers and officials of
agencies like the World Bank and International Monetary Fund have begun to
think – and discuss – the unthinkable. IMF chief Christine Lagarde warned this
week that Greek's departure from the euro would be “quite messy” and
"extremely expensive."
Analysts who are looking at the
potential impact say the losses and economic pain would be widely felt.
Replacing the euro with a new,
devalued currency would wipe out much of the remaining assets on Greek bank
books. Europe’s central bankers have already pulled back some forms of funding
for Greek banks that have been hit hardest by withdrawals. Hundreds of billions
worth of additional borrowing by Greek households and businesses would be in
legal limbo.
Any new currency – or a return to
the pre-euro drachma – would be massively devalued, by some estimates as much
as half the value of a euro. That would help Greece’s economy eventually get
back on a growth path because it would make its products and services cheaper
for buyers spending dollars and euros. A week’s vacation in Crete would cost
half the price of a comparable trip to Sardinia.
But Greek households and businesses
would bear the immediate pain. Imported goods and commodities like oil would
suddenly cost twice as much. Households and businesses making good on
outstanding loans written in euros would see repayment double in local currency
terms.
European officials who engineered
the costly plan to “save” Greece -- led by France and Germany -- would also
feel the pain. Much or all of the more than $200 billion in loans already
extended to the Greek government by the IMF, European Central Bank and Europe’s
private banks would be at risk. That would mean explaining to French and German
taxpayers what went wrong with the grand plan.
It would also raise the political
costs of extending further bailouts to weaker, debt-burdened countries
including Spain and Italy. As Greece demonstrates that a once-unthinkable exit
from the euro is now possible, other countries may follow. If investors
continued to shun Spanish and Italian government bonds and depositors flee
their banks, the choice facing Europe grows more stark.
Worries about the fragmentation of
Europe’s monetary union have already sapped business and consumer confidence
and brought the region’s economy to a dead stop. Government austerity measures
imposed on weaker economies are driving them deeper into recession.
As that recession spreads, the pain
of Greece’s departure from the euro would be felt even more broadly, according
to Michel Juvet, an economist at Bordier, a Swiss bank.
“At the same time we have China,
which is slowing down very, very fast, we have the U.S. economy, which is
losing momentum, and we have this global slowdown, “ he said. “All economies
are so connected that when one country or one big zone is suffering, the others
are suffering as well. This is globalization.”
Others see the crisis in starker
terms.
“This is phase two of the global
financial crisis," said R. Seetharaman, CEO of Doha Bank in Qatar.
"That’s the reality."
