Thursday, May 6, 2010

The domino effect

The big issue today is whether the debt crisis will spread to other vulnerable countries such as Spain and Portugal. In the decade since the introduction of the euro, the economies on the continent have become increasingly interwoven. With cross-border banking and borrowing, many countries on the periphery of Europe owe vast sums to one another, as well as to richer neighbors like Germany and France.
This means that there is a domino effect. I quote here the New York Times (2 May) :

The first domino is Greece. It owes nearly $10 billion to Portuguese banks, and with Portugal already falling two notches in S. & P.’s ratings and facing higher borrowing costs, a default by Greece would be a staggering blow. Portugal, in turn, owes $86 billion to banks in Spain; Spain’s debt was downgraded one notch last week.
The numbers quickly mount. Ireland is heavily indebted to Germany and Britain. The exposure of German banks to Spanish debt totals $238 billion, according to the Bank for International Settlements, while French banks hold another $220 billion. And Italy, whose finances are perennially shaky, is owed $31 billion by Spain and owes France $511 billion, or nearly 20 percent of the French gross domestic product.'

The whole euro system is in danger. There are no simple solutions, but maybe we should think about a plan B on debt restructuring as suggested by N.Roubini (FT 30 April) if things go wrong. We can bail out Greece, but not all euro area countries.

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