Coming only days before the leaders of the world’s Group of Eight industrialized nations meet at Camp David, the standoff in Greece over its political direction has thrust Europe’s troubles to the top of the agenda. A downturn in Europe could stagger a fragile recovery in the United States and undermine growth around the world.
Fighting a new downturn would be a challenge for the major economies, many of which have not fully stabilized since the last big economic crisis.
After the 2008 collapse of the Wall Street investment bank Lehman Brothers, the United States, Europe and China unleashed trillions of dollars in economic stimulus to limit the blow to global markets and encourage a turnaround. With growth in China slowing and U.S. officials looking to tame record government deficits, that sort of massive reaction is unlikely — leaving Europe, in a sense, operating without a safety net.
The global leaders will gather at a vulnerable time for major economies, with most of the countries in the group struggling to cope with levels of public debt unseen since World War II, high unemployment, and years of potentially painful austerity in the offing.
In recent weeks, Spain’s borrowing costs have been rising to dangerous levels, with investors losing confidence in the country’s fiscal health. And on Monday, Moody’s downgraded the credit standing of all Italian banks because of financial problems in that country.
The economic worries are roiling politics. President Obama faces a reelection contest that will largely focus on the economy. French voters recently ousted their president amid a public backlash over government austerity programs. Italy is battling to avoid needing an international bailout. And German Chancellor Angela Merkel, whose party was stung over the weekend by losses in regional elections, is trying to maintain Europe’s focus on debt control even as the risks of cutting too far too fast are becoming apparent.
In that context, Greece’s political infighting might seem a sideshow. The country’s economy is tiny, and its financial system has been largely quarantined over the past two years from the rest of the world. It still owes a lot of money. But Greece’s debts now rest mostly with institutions such as the European Central Bank and the International Monetary Fund, which are in a better position than private investors to absorb the shock if Greece reneges on its obligations and, as a result, drops out of the euro zone.
An exit by Greece, however, is still a scenario Europe wants to avoid. If Greece drops out of the currency zone, investors might grow concerned that other countries could follow suit. In turn, that could endanger the larger Italian and Spanish economies if investors decide they are too risky and stop buying their bonds. The fallout could be severe — a possible worldwide drop in lending as banks try to avoid risk, and a downturn in trade, investment and other economic activity.
“The costs of a default and euro exit by Greece are so high — both for Greece and for other euro-area members — that a way out of the crisis will be successfully navigated,” analysts at Barclays Capital predicted. “However, the risk of a messy and damaging crisis has certainly increased.”
In return for international bailouts exceeding $200 billion, Greek officials have agreed to sustained efforts to control spending and overhaul economic policy. While polls show Greeks favor staying in the euro zone, austerity and related measures have become increasingly unpopular, leaving the country’s two main political parties without a clear parliamentary majority in recent elections.
An exit from the euro could ease the short-term burden of the current austerity drive. With control of its own monetary policy, Greece could set the exchange at levels that would boost its exports and make imports from elsewhere in Europe more expensive.
On Monday, Greek President Karolos Papoulias, the nation’s head of state, met with leaders from the conservative New Democracy party and the Socialist Pasok party to forge a new government. But the far-left Syriza party, which opposes the international bailout program and the economic measures required in return, declined to participate.
Syriza finished second in the May 6 elections, and its refusal to negotiate with the other major parties has made it likely that Greece will be forced to hold new elections next month. Talks are to reconvene Tuesday.
Economists and officials say Europe is in a better position to weather a Greek exit than it was a year ago. That’s in part because the European Central Bank has sought to ease credit for hard-hit banks and the region’s politicians have pledged more than a trillion dollars to several bailout funds.
But even some of the region’s cheerleaders acknowledge that a Greek departure would have uncertain consequences at a time when Europe is economically vulnerable. New data Monday showed that European industrial production fell in March, and economists expect statistics this week to confirm that the region’s economy contracted in the first three months of the year.
“Greece has no option but to reform and to repay [its debts], and if it doesn’t do that, it will be a very serious problem, not just for Greece but for everyone,” Dutch Finance Minister Jan Kees de Jager said in Brussels, where the region’s financial leaders were meeting Monday, Reuters reported.
Faiola reported from Athens.