Q&A Time: European Debt Crisis

Question:

What is the likely future of the euro? Will the PIIGS nations be kicked out of the European Union, and why wouldn’t Greece want out?

Answer:

Throughout the summer, fears of a default by Greece on its debt have reemerged. This has caused turmoil in the European financial sector which has high exposure to government bonds from Portugal, Ireland, Italy, Greece and Spain (the PIIGS nations). For the European Monetary Union to hold together, economically strong countries France and Germany will have to provide some sort of bailout to Greece. German Chancellor Andrea Merkel has been attempting to gather support for an aid package, but her political party has been weakening in Germany, and the population does not want to foot the bill. Without aid, it is almost a certainty that Greece will default, which may lead to the end of the Euro as a currency. The market believes that Greece will default as the yield on two-year Greek bonds has risen above 50% this week. We believe the European Union will not come to an end, but the end of the unified currency, the euro could be near.

U.S. Exposure

If Greece defaulted on its debt, European banks could have some trouble. The U.S. Federal Reserve claims that U.S. banks have little exposure to Greek debt and the debt from other PIIGS nations. The likelihood of a significant impact on the U.S. financial system has supposedly been minimized. European banks could face a situation similar to the financial meltdown experienced in 2008-2009 in the United States.

Could Greece Leave the Eurozone?

It would be possible for Greece to leave the unified currency; however, the consequences would be dire for the Greek economy. Greece would likely lose all support from euro countries. They would have to create a new currency—a new drachma—which could rapidly devalue. Greece would then be able to pay off their debt at a lesser value at the cost of high inflation. Importing goods and resources to Greece would be difficult. If the euro dissolves and European countries revert back to pre-euro currencies, the U.S. dollar would likely appreciate and be very strong against the individual currencies.

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