If Europe's crisis continues to deepen, it could cause market chaos globally, threatening our economy and others.
Q Why is Greece in turmoil? Didn't it get a bailout last year?
A Greece's elections on May 6 left it without a clear coalition government and could spark new elections. It increased the chance that a radical leftist, Syriza party chief Alexis Tsipras, could lead Greece. He's called for exiting the European Union and scrapping last year's bailout deal with bondholders and E.U. governments. Even if he fails, the chances for a consensus government don't look good. That means whatever past leaders negotiated with bondholders soon may no longer apply.
Q What's the significance if Greece leaves the E.U. or balks on the deal?
A Some analysts fear that a Greek departure could be akin to yanking a card out from a stacked house of cards. Maybe nothing happens -- or maybe the E.U. structure collapses. Spain, Italy and Portugal all have political, economic and debt dynamics that somewhat mirror Greece -- but they're much larger economies. If Greece exits -- breaking a deal in which bondholders agreed to eat losses on old bonds in exchange for getting new Greek bonds -- it could lead to calls for the same exit by other troubled E.U. economies. A precedent would be set, and investors likely would demand higher interest rates in exchange for buying Spanish, Portuguese and Italian government bonds. These nations could fall even further into debt.
Q How are the larger economies in Europe faring?
A Germany continues to outperform Europe, but economic conditions have worsened across the continent. "The unemployment rate in the euro area has reached a record level of 10.9 percent and the large drop in April manufacturing ... suggests a higher risk of a deeper and longer recession," said the Institute of International Finance, the trade group for international banks. The outlook for Europe is darkening.
Q Are European governments still on the same page?
A Increasingly no. French President-elect Francois Hollande is promising a government stimulus program to spark economic activity, and that's a reverse emphasis from the belt-tightening measures of his predecessor, Nicolas Sarkozy. Hollande takes office Tuesday, and his election has complicated relations with Germany's conservative chancellor, Angela Merkel. She and Sarkozy were so close they were referred to as Merkozy. Responding to her voters, she's championed austerity as the answer to Europe's debt crisis.
Q What's the big deal if Germany and France don't get along?
A The nations are Europe's two most important economies, and their partnership is the axis upon which the E.U. is based. That the leaders of Europe's top two economies have very different solutions to the debt crisis is problematic for E.U. cohesion.
Q What would happen if the E.U. fell apart?
A Europeans for more than six decades have strived for political integration secured through economic integration, as an antidote to the rival nationalisms that led to two world wars.
First they created a common market that eliminated borders for participating members, then they adopted a common currency, the euro. Governments across the world hold euros along with dollars to facilitate currency trade; losing one of the world's reserve currencies could prove traumatic for the global economy.
U.S. corporations that operate in Europe could face having to operate in a number of different currencies. This adds risks and costs to their bottom lines. Currency trading represents one of the larger segments of global finance. If investors begin to think the euro might disappear, Europe might see the mother of all credit freezes, which could slow the global economy.
"The failure of the euro area will be a calamitous financial event. If one believes the euro might fail, one should avoid being invested in European financial institutions, and in euro-denominated assets, until the outcome of the new pattern of currencies is clearer. As a result, a large swath of euro-denominated assets would quickly fall in value," wrote scholars Peter Boone and Simon Johnson.
"The euro itself would cheapen sharply, but so would the value of European bank debt and European shares, and most sovereigns [nations] would see their bonds trade off sharply. This in turn would make it expensive for even the Germans to raise finance in euros. ... They would be attempting to issue bonds in what is perceived as a flawed curency."
In such circumstances, the European crisis then would spread, because global investors are deeply involved in what are called currency swaps. These are hedges made against value shifts in currencies. These swaps are commonly used by banks, pension funds and insurance companies in order to meet their long-term commitments to make payments in the future.