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Sunday, June 21, 2015

Will Greece be Source of "Economic Contagion"? BBC

Will Europe Get Greek 'Flu?

By Andrew WalkerBBC World Service Economics correspondent
  • 1 hour ago
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  • From the section Business
Greece and EU flags held aloft in front of the Greek parliament building
The last time Greece was on the brink the word on lips around the eurozone was "contagion". 
If Greece went, would others be the next targets in the financial markets? Would they find themselves pushed relentlessly towards the eurozone's exit? 
This time we are actually closer to Greece leaving, and yet there is very little sign of the dreaded contagion. In 2011 and the following year there was a lot of it about. Not so today. 
Why? It's largely down to the European Central Bank ECB). 

Bond issues

But perhaps the first thing to spell out is what that earlier contagion looked like. 
The key element was the impact on the market for government debt, the bond market. Investors worried that some governments might struggle to maintain their debt payments. 
They also worried that if any of those countries did end up leaving the euro, the debts would be repaid in a national currency that would in all likelihood lose value. 
Inevitably investors buying the bonds concerned wanted compensation for the risk in the shape of a higher return or yield. 
When the return on government bonds in the market rises, it generally means the government will have to pay higher borrowing costs when they next raise money in the markets. 
There's a vicious cycle that can get going in these circumstances. 

Benchmark

If a government's ability to pay its debts is looking suspect that tends to raise its borrowing costs, which in makes it harder to maintain the payments, making borrowing more expensive still. 
That is what happened when the eurozone turmoil was at its worst. A benchmark often used is the return or yield on government debt that is due for repayment in ten years' time. To take two countries at the eye of the earlier storm: for Italy that figure peaked at 7.2%, for Spain 7.5%. 
Earlier this year those figures went below 2%. They are a little higher now but still at eminently sustainable levels. 

Transformation

The leading force behind that change is the European Central Bank. 
In August 2012 it unveiled a programme with the characteristically snappy title of "Outright Monetary Transactions", or OMT - you might well respond with OMG! 
What did it mean? The ECB was ready to go into the markets to buy the bonds or debts of governments where their borrowing costs reflected "fears of the reversibility of the Euro". 
The mere willingness to do it transformed the situation. A decline in eurozone government borrowing costs began. It sent a message to the markets that even if one country was in difficulty, the others would stay in the eurozone. 
So how much has the ECB spent under this programme? Nothing. Nada. Not a single euro. The commitment itself was enough to break the vicious cycle. 

Reinforcement

More recently the ECB has started really spending money in the bond market, under the quantitative easing programme it launched earlier this year.
This was not aimed at addressing risks of eurozone break-up. It was intended to deal with deflation or falling prices, but it has reinforced Europe's defences against contagion from the crisis in Greece. 
It is not focussed on countries that have stretched government finances.
In fact Germany gets the largest share of the bond purchases. But others get some too (except for the time being Greece, because the ECB already owns a lot of Greek debt). That too helps to keep their borrowing costs down.

Banking union

There are other factors. The great majority of eurozone governments have reduced their borrowing needs since 2012 - by a lot in some financially stretched cases such as Ireland and Spain, which have cut government spending and seen tax revenues improved by a return of economic growth. 
Italy's borrowing needs have also come down, but less impressively as its economy has continued to flounder. 
The progress the eurozone has made towards banking union probably helps too. 
Bear in mind that one of the reasons that investors became worried about government finances was the expense of bank bailouts. 
So anything that makes the banks safer also makes government finances more sustainable. Banking union probably has helped in that respect, though it is unfinished business. 

Weathering

In the current episode of the Greek there have been occasions when other countries have been affected, but the scale of the impact has been tiny, compared to a few years ago. 
That has helped European Leaders come to the conclusion that they can weather a Greek default and exit. 
Maybe they can, but there are some who regard that view as complacent. The US Treasury Secretary Jack Lew said just last month "The notion that the risk is completely contained, that there's no contagion -- I think that it's a mistake to think that a failure is of no consequence outside of Greece. We don't know the exact scope".

Greek debt crisis

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