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07 July 2015

Deutsche Welle: Why Greece won't trigger a global crisis

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(7th July) Limited private sector exposure and massive public sector intervention means little risk of financial contagion spreading from Greece. But there is one area of uncertainty: European politics.

"The more time you see that a country is being downgraded, that the assessment points to a higher probability of default, you have time to unwind that exposure," said Carmen Reinhart, an economist who researches financial contagion at Harvard's Kennedy School of Government. "That's essentially what has happened since 2010."

Meanwhile, the public sector has expanded its role in financial markets since the 2008 crisis, reducing the risk of contagion.

"There's been almost an overreaction to 2008 in terms of intervention by central banks and governments and the tightening of the safety net," Michael Bordo, an economic historian at Rutgers University, told DW. "We're not going to have a repeat of 2008."

Limited exposure

The private sector now holds just 17 percent of Greece's debt, according to Bloomberg. The International Monetary Fund, the European Central Bank and the European Union hold 80 percent of the country's debt. According to Reinhart, the distinction between private and public sector exposure is an important one.

When private financial institutions have too much leverage, their assets take a hit and they can no longer lend to their peers. Credit markets can freeze up as a result. But a public sector financial institution like the ECB operates on another level.

"The ECB can print euros that facilitates things just as the Bank of England or the Federal Reserve can print pounds or dollars to deal with a situation," Reinhart said. "The Central Bank of Greece cannot do that."

Which means Greece is essentially at the mercy of the ECB. On Monday, the ECB declined to increase its emergency assistance to Greece, making a default more likely. While a Greek default and possible exit from the eurozone would be devastating for the country's economy, it will have little impact on the ECB's ability to lend to other potential trouble spots, like Portugal.

The wildcard: European politics

So if there's little risk of European and global contagion, then why has Greece caused volatility on financial markets? According to Bordo, it's because European politics are often incoherent, which creates uncertainty.

"Because you're getting conflicting statements every day from the European authorities, people don't know what's really going to happen," he said. "It's not operating like a clean monetary union, like the United States or Canada."

It's still unclear how the financial markets will interpret the outcome of the Greek crisis. There's a possibility that markets will view a Grexit as a precursor to the unraveling of the eurozone.

"If that's how the markets perceive it, that could have negative effects," Bordo said. "The countries that are next on the list - Portugal is pretty small, Spain is not so small, and Italy is definitely not so small. That's the worst-case scenario."

Full article on Deutsche Welle

© Deutsche Welle

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