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.