Tuesday, June 21, 2011
This post is, even more than most blog posts, a collection of speculative musings. I'm putting it out there in the hope that people will make arguments or point me to links that will either refute or confirm what I'm suggesting or at least sharpen up my thinking.
The gist of this is that I'm having trouble with the idea that there is a serious global risk from the situation with the PIG countries (I'll leave Spain out of it for now, since there are signs of Spain beginning to recover). The three worst off countries have their nominal GDP above (source), and at least Ireland and Greece are still shrinking in economic terms as of the last available data.
For the sake of discussion, I'd like to posit that these countries cannot pay back their debts, that the current austerity measures in an attempt to do so are causing ongoing economic contraction, that this will not be politically sustainable, and that, either sooner or later, these countries will default.
The other possibilities are that austerity minded governments somehow manage to hold on to power long enough to eventually pull the economy through the contraction phase, or that the rest of Europe decides to stop treating this as a liquidity issue and out-and-out give money to the affected countries to stimulate their economies. I'm not certain these cases are impossible but let's posit that they don't happen and that two or three of these countries default, and possibly exit the euro-zone as a result. This is in a spirit of analyzing the worst reasonable case.
So there's little question that a default will cause considerable further degree of economic pain in the affected countries. However, I'm not persuaded that there is a case for all that much contagion. In terms of direct effects, these economies are small:
Even if they were to contract in half, it's not that large on the scale of the whole Eurozone, and the trade effects on the rest of the Eurozone will be smaller than the contraction of these economies themselves.
Then in terms of the balance sheet/financial contagion: at the moment, I can't find evidence that the exposure is large enough. The other day, commenter John pointed to this Guardian post with data from UBS about bank exposure to sovereign Greek debt:
Look at the "% of equity" column. Banks over 100% will be insolvent if Greece defaults. The upshot is that there are no banks outside of Greece that are going to go under if Greece defaults, even if it does so 100% (which is unlikely). There are banks that will be hurt and may have to raise capital, but none that will be insolvent or unable to operate. And presumably, the banks exposed to Greece are by and large not the same ones exposed to Ireland.
In other words, if Greece and Ireland go down in flames, exit the Eurozone, turn into Argentina, whatever, I don't see how it causes more than a mild recession, if that, in France, Germany, etc. Still less the United States.