Question About The Greek Economic Crisis And The "Contagion" Theory.

Let me prface my remarks by saying I can empathize with the Greek people but can how can such a small economy have such a large effect on the world economy?

I could see if it was the Chinese, Japanese, German, or even the British economy.

in a small town with two banks. Imagine each of those banks lent you unspeakable amounts of money, say $10 billion, with ever increasing interest rates on new loans allowing you to pay back the old ones. Then the jig is up, and nobody else will loan you money to pay back the existing loans. Those two banks are still going to be out $10 billion, and may fail, or be unable to loan $1 million to a solvent person who wants to build a little restaurant.

It's not contagious because of the size of the greek economy, which is neither here nor there. It's contagious because of the size of the loans (bonds) made to the Greek government, and the effect that would have on credit more generally.

But wouldn't the size of their loans be more or less proportional to the size of their economy and therefore be only a small fraction of the total loans outstanding.

For instance if I can't repay BOA I'm not going to bring the entire banking industry down.

But it's complicated by the fact that there are a lot of other Euro countries in similar situations. If Greece defaults, that makes it much more likely the other countries will default as well, which will balloon interest rates and ultimately hurt the stable Euro countries because they are all on the same currency.

Spain is in trouble for example - these other economies are lined up
like dominoes.

These are all the problems created in the Reagan/Thatcher days
coming home to roost.

They gave more loans to Greece than the size of the economy dictated. It's as if BOA *would* give you 30 billion in loans.

If Greece implodes and it stops there it would be a non-issue.

However Greek economy has a lot of the same problems as Spain, Portugal, and Italy.
All 4 nations combined are about 20% of the Eurozone. Now we are talking about a larger risk.

Greece near failure has shaken confidence of bond investors in those other countries. If Greece can fail then Spain can fail too.
This makes it harder for Spain and other to refinance their debt which makes it harder for them to balance their budget.

If all 4 nations collapsed the fear is that it could bring down the EU and the fear then is that would bring down the world's economy.
China actually exports more to EU than the US. A massive slowdown in exports to EU would derail China and dominoes start falling.

So if Greece implodes on a macro-economic scale nobody really gives a flying crap. The fear is the contagion.

It is already spreading. Yields on Spainish debt in secondary market have increased 300 basis points since start of the year. If Spain can't refinance its debts at a reasonable interest rate (and has a lot coming due this year) then it will need a bailout too.

I am with you... the whole Greek crisis is $140 billion and it seems like the tail wagging to dog.

The threat isn't so much to other nations as it is to European banks. ($140 billion is a lot for a bank.)

And if the Greek debt is largely forgiven then Spain and Portugal will want the same deal Greece gets.

Most importantly, though, if Greece defaults then it changes expectations about nations with comparable fiscal situations.

And there are currency problems. If fixing Greece affects the Euro that affects the trade balances of all the Euro nations.

(If Greece was not on the Euro nobody would care about this. They could be handled in isolation)

I don't pretend to understand it all but I know that in the 1880s a terrible recession in Europe was caused by the failure of a bank in Ohio, USA.