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Greek Default and its Effects on EU and Global Markets

If you switched on your television this morning, you would no doubt have seen scenes of ordinary Greek citizens protesting in the streets against the austerity measure imposed on them as a result of the Greek financial crisis.
The government of George Papandreou is fighting for its survival and the finance minister has already lost his job. It seems ever more likely that Greece will default on its debt, if not now, then at some or other stage in the not so distant future.
The country is caught up in an evil downward spiral of a shrinking economy resulting in lower government income. This means the government has less money to stimulate the economy and to pay its debts, which in turn leads to further erosion of confidence and a new round of economic contraction.
Greek government bonds have been downgraded to ‘junk status’ – a further blow to the debt-stricken country that will make it even harder for the government to obtain finance on the open market for years to come.
Despite German Angela Merkel and French Sarkozy promising “lasting, global and quick responses before the end of the month” fears of a Greek default are causing havoc on European and world markets.
The European Union, the European Central Bank, and the IMF are currently locked in negotiations on whether to release the latest instalment of the €110 billion rescue package approved for Greece 17 months ago.
European Commission President Jose Manuel Barroso meanwhile warned of ‘unforeseen consequences’ in the event that Greece should default on its debt repayments.
One scenario is that Greek should be allowed to default, be declared bankrupt, and leave the EU. The EU, however, is convinced that this option would not be the best for all concerned. It no doubt fears that such a move could be the beginning of the end for the EU, with countries such as Italy and Spain eventually going the same route.
The French and German proposal is that banks should be recapitalised to restore confidence in the European banking system. They do, however, not agree on how this should be done. Germany wants the banks to first try and find new investors on their own, while France, perhaps a bit more realistic, wants to use EU funds for this purpose.
The biggest problem with the Greek debt crisis is not simply its effect on the Greek economy. A Greek default would cause havoc in the European banking system and the ripple effect might be so enormous that we could well see a new worldwide banking crisis.
The reasons are twofold: In the first place, Greece owes countries such as Spain, France, and Italy a lot of money. Fear of a Greek default has already caused the credit rating of several major banks in these countries to be downgraded.
The inter-connectedness of the world economy means that if this should happen, the crisis might well spread to other European countries and eventually around the world. If would mean that countries with high debt ratios could find it nearly impossible to obtain finance for many years to come – effectively stifling economic development in most of these countries.
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