Greece crisis poses risks to an already-slow global economic recovery
The situation in Greece is complicated. Countries all around the world are starting to worry about the possible consequences of the Greeks falling outside of the euro. On the other side of the pond, the U.S. Federal Reserve keeps waiting for the right time to adjust its interest rates.
After the global economic crisis, the world is not the same. One way we see this change is in the behavior of investors, who are acting more cautiously and moving away from their investments when uncertainty arises.
Capital flight from one country to another is what creates the biggest damage. And the damage is even worse when capital flight occurs so quickly that banks are faced with liquidity issues. This is the case with Greece, where the government has limited the amount of money people can withdraw from their bank accounts.
Patterns emerge
This situation resembles the Argentine crisis of 2001. At that time, not only bank transactions were restricted; most of the money deposited at Argentina-based banks as foreign currency was taken from the hands of the public with a direct order from the government of President Fernando de la Rúa.
In both of these cases, it is not just the economy as a whole that suffers; businesses and people suffer, as well.
Since the most recent crisis, the recovery process has been very slow for most countries because they are coming out from too much debt and are restrained by a substantial economic slowdown. The tools of monetary policy have not always been sufficient for these cases and other strategies are necessary when trying to manage poor economic performance.
This is not just affecting the western world. Earlier this week, the Shanghai Composite fell 5.9% to 3507.19 and a cumulative drop of 32.1% since the second week of June. This dive in Chinese stocks is not only a result of the Asian economic slowdown; it is also a sign of general aversion to risk and current global uncertainty.
Greece’s economy is also facing the isolation that bad political and economic decisions create, due to the fact that Europe overall is not struggling as much as Greece. After the “No” vote this past Sunday at the polls, European authorities are going to have to compromise and find a sustainable solution for both parties. Greece asked this week for a three year rescue package of €50 billion.
Tough choices
Remaining in default is not an option, unless, of course, Greece wants to face the same issues that Argentina is confronting due to its objection to negotiations with its creditors. Normally, a decision to run an economic adjustment and pay what is owed creates current costs but generates future benefits.
Some economists around the world are stating that monetarists are incorrect in claiming that an increase in the amount of money in the economy creates inflation. While this is merely economic theory, in Europe, inflation does not indeed occur because people are not consuming enough.
Of course, the European Central Bank (ECB) takes this into consideration when doing its open market operations, or when printing more Euros. Now remains the question: is the ECB going to let Greece be the nation that absorbs a huge part of that money?
Even if European consumption stays at its current level, and Greece stays on the euro, Greece is going to struggle to boost its economy. On the other hand, if Greece falls out of the euro zone, the possibility of the country being able to pay its creditors will diminish. The Greeks might never be able to repay such debt with a weak drachma.
Not only does Greece lack the capacity to print its own money, it also suffers from an absence of economic resources to confront such a drastic change. Greece depends on tourism, and its people need a strong currency to balance out such activity. Greece needs visitors spending more money in the country, not paying less because of a devaluated currency.
Where the Fed fits in
For months, we have been hearing rumors that the Fed might soon change interest rates. Even when the US fully recovers, such actions will unintentionally harm weaker economies due to a stronger dollar.
This is not only a concern to our globalized financial system; it is also a problem regarding commodity prices. Investors appear worried, and we are observing massive sell offs, together with a natural ebb in liquidity.
The problem that we ought to see is that we have a bigger supply of money, in the form of savings, which is ready to be invested. But the companies that could use those resources are not keen on tapping into them due to the current low levels of activity in the emerging markets.
Moreover, if the Fed hikes up rates, we will witness capital flight to the US, and European rates will have to eventually follow that rise. This kind of adjustment could compound the disadvantageous situation in the smaller European economies that are already struggling.
