Europe's recovery could collapse under the weight of Greece's debt

Now that the credit bubble has burst, the euro impedes recovery. One way countries revive from financial crises is by depreciating their currencies. This makes exports and local tourism cheaper, creating some job gains that cushion the ill effects of austerity elsewhere. But latched to the euro, Greece and other vulnerable debtors forfeit this safety valve.

Greece’s debt is now approaching an unsustainable 160 percent of its annual economy (gross domestic product). If it defaulted, investors might dump bonds of other weak debtors for fear that they, too, would default. That could send interest rates soaring and saddle European banks with huge losses. At the end of 2010, Europe’s banks had about $1.3 trillion of loans and investments — both governmental and private — in Greece, Ireland, Spain and Portugal, reports the Institute of International Finance, an industry research group. A banking crisis would imperil economic recovery.

So Europe is playing for time. It’s struggling to delay any Greek default long enough for other vulnerable countries to demonstrate that they can handle their debts. The very process makes the euro — contrary to original intent — a source of contention, as nations shift blame and costs to others. Given Europe’s huge debts, even the holding action may fail. It may merely postpone a broader crisis. “They may dodge this bullet,” says Lachman, “but not the next.”