Greece's debt crisis could spread across Europe
By Neil Irwin
Washington Post Staff Writer
Friday, May 7, 2010
MADRID -- A third straight day of decline in world financial markets on Thursday was vivid evidence of a scary proposition: That the fiscal crisis that began in Greece months ago is spreading across Europe like a virus, causing growing doubt even about the fates of nations with far more manageable levels of government debt.
It is called the contagion effect, economists' metaphor for the rapid and hard-to-predict spread of a financial crisis, and it's driven by the fragility of investors' perceptions. Contagion is a function of vicious cycles in which confidence in a country's ability to repay its debts falls. If investors lose piles of money on the debt of one country, they assume that owning the debts of other countries with similar finances might cause them to lose even more. So they sell their investment in the second country, which in turn must pay higher and higher interest rates to get any loans, which adds to its debt and creates a fiscal death spiral that can well move on to the next country.
Spain is in the path of the storm and at the mercy of global investors, who are operating under the twin pressures of fear and greed. The country has less debt relative to the size of its economy compared with the United States or Britain, but contagion can threaten even countries that have managed their government debt responsibly if investors change their views about the country's future deficits or ability to handle debt.
The odds of a full-blown sovereign debt crisis have risen significantly over the past two weeks and especially after the market turmoil Thursday, such that Europe in 2010 looks increasingly like East Asia in 1997 and 1998, when a currency devaluation in Thailand sparked a broad crisis in South Korea, Indonesia and elsewhere.
(More here.)
Washington Post Staff Writer
Friday, May 7, 2010
MADRID -- A third straight day of decline in world financial markets on Thursday was vivid evidence of a scary proposition: That the fiscal crisis that began in Greece months ago is spreading across Europe like a virus, causing growing doubt even about the fates of nations with far more manageable levels of government debt.
It is called the contagion effect, economists' metaphor for the rapid and hard-to-predict spread of a financial crisis, and it's driven by the fragility of investors' perceptions. Contagion is a function of vicious cycles in which confidence in a country's ability to repay its debts falls. If investors lose piles of money on the debt of one country, they assume that owning the debts of other countries with similar finances might cause them to lose even more. So they sell their investment in the second country, which in turn must pay higher and higher interest rates to get any loans, which adds to its debt and creates a fiscal death spiral that can well move on to the next country.
Spain is in the path of the storm and at the mercy of global investors, who are operating under the twin pressures of fear and greed. The country has less debt relative to the size of its economy compared with the United States or Britain, but contagion can threaten even countries that have managed their government debt responsibly if investors change their views about the country's future deficits or ability to handle debt.
The odds of a full-blown sovereign debt crisis have risen significantly over the past two weeks and especially after the market turmoil Thursday, such that Europe in 2010 looks increasingly like East Asia in 1997 and 1998, when a currency devaluation in Thailand sparked a broad crisis in South Korea, Indonesia and elsewhere.
(More here.)
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