A lot of people have been asking me about the debt crisis in Greece. They hear bits and pieces, but don’t fully understand why it happened, what’s going on now, and why it’s affecting us. So, briefly, here’s the scoop to bring you up to date.
What happened in Greece?
So the thing is, the EU (European Union) was never supposed to be in this situation (for good reason – look at the trouble it’s caused!). When the European Union was created, they adopted what is called the Stability and Growth Pact. This pact was supposed to ensure that all members of the European Union would follow a strict financial criteria. The most important and critical criteria in the pact was that any member of the EU could never have a national debt that was more than 60% of the national GDP. This is an extremely conservative number and has been known to inhibit economic growth. Unfortunately, just like any good intention or New Year’s resolution, no member of the EU adhered to this rule, and particularly the two largest economic powers, France and Germany so the pact was dissolved after awhile.
Greece’s debt level, ever rising, was going unnoticed during “good” economic times. When the recession hit in 2008, investors started to wonder whether or not Greece would be able to pay off its debt. Therefore, the yields for Greek Bonds increased. Since the EU has a would question Greece’s debt increase, they lied to the EU and paid Goldman Sachs millions in fees to lend them money through different intermediaries that would not be associated with “national debt”. The result was that Greece was going to default. The EU stepped in and loaned Greece money to help stabilize the country. They gave money to Greece in February, April, and, again, in May of 2010. Greece was still not able to stabilize their finances. The money from the EU was unable to solve the problem. In October of 2011, the EU agreed to write off 50% of Greece’s privately owned debt and loaned the nation more money once again to help them get out of this situation.
So why does the US market keep fluctuating even though the EU has continued to give Greece support? Well, there are two reasons. The first reason is that every time the EU has given Greece money, they’ve put more restrictions on the nation’s budget in exchange. Both the government and the people are feeling overwhelmed with these sudden and dramatic budget cuts that entailed significant lifestyle changes. Wages were cut, benefits were slashed, and with little to no notice to help prepare for these changes. The second reason is that the EU cannot keep giving Greece money forever, because each time the EU gives Greece another bail out, they are one bail out closer to being insolvent themselves. The EU cannot afford to keep bailing Greece out. At some point in the near future, the EU will have to borrow from another country outside the Union. So risk increases with every request for a bail out.
How does this affect the U.S. markets? As you know, we export and import to most countries. The U.S., along with many other countries, holds some of Greece’s debt; Japan, for example, holds 432 million dollars in Greek debt. If Greece defaults on their loans, Japan will only get about 30% of their investment back – YIKES! That is a lot of money! So then Japan, the EU, the U.S.
and many other countries will head towards or plummet into another financial crisis. This is because they will lose a lot of money on their investments, and therefore, they will not be able to efficiently trade and do business. So as news comes out about whether or not Greece is going to remain solvent, the U.S. markets fluctuate to prepare for the worst.
Are you worried about your investments now? I did not mean to scare you and for the moment, it looks like Greece is going to make it through this mess. The last negotiation not only allowed Greece to let go of 50% of its debt but gave them a very healthy bail out package. To avoid a crisis like this from happening again, the EU has created an independent auditing committee to audit each member of the EU on a yearly basis to ensure they are not cooking the books or overspending.