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Global Markets Rankle Over Greece’s Deepening Debt Crisis

April 27, 2010 at 12:00 AM EDT
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Downgrades of Greece's debt rating to junk status sent markets tumbling in Europe and the U.S. Gwen Ifill talks to financial expert Eswar Prasad about the far-reaching effects of the European nation's economic crisis.
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GWEN IFILL: And, finally tonight: a financial crisis far from Wall Street that’s reverberating around the world.

After months of financial turmoil, Greece’s credit rating was downgraded to junk status today. That, in turn, sent markets tumbling throughout Europe and in the United States.

Just days ago, Greece asked European governments and the International Monetary Fund for $60 billion in rescue aid. But Germany has resisted.

To help us understand why the debt crisis in Greece is having such far-reaching effects, we turn to Eswar Prasad, a professor of trade policy at Cornell University and senior fellow at the Brookings Institution. He previously worked at the IMF.

Welcome.

ESWAR PRASAD, professor of trade policy, Cornell University: Good evening.

GWEN IFILL: How significant is it that these — this debt downgrading happened today?

ESWAR PRASAD: This is very significant for a variety of parties.

First of all, it’s very significant for Greece, because it means that they’re going to have a great deal of trouble refinancing their debt. And they are almost certainly going to have to require a rescue package from the IMF and the European Union.

It’s going to reverberate in the rest of Europe as well, because there are countries that are equally vulnerable, countries like Portugal and Spain, that are going to come under a lot of pressure.

GWEN IFILL: In fact, Portugal today had its — its ratings downgraded as well.

ESWAR PRASAD: Indeed.

It has implications for the euro area as well, because now there are questions about whether many of these countries do really belong in the euro area and whether it’s sustainable. And there are concerns overall about sovereign debt in the small industrial countries, as well as in emerging market countries.

And this is leading to a potential flow of capital away from those countries towards the U.S., so that implications come to the U.S. shores as well, because, as money comes to the U.S., it makes it easier to finance our deficit, but pushes our exchange rate up.

GWEN IFILL: When you talk about the euro area, we’re talking about all the European nations who all have the single currency. Does — has that created kind of a domino effect; when one country suffers, everybody else feels the effect more keenly?

ESWAR PRASAD: It makes it much more important that investors take a closer look at those economies. The problem is that the euro area was built on the premise that it would impose discipline on those countries.

Each country in the European Union was supposed to have a deficit less than 3 percent of GDP and debt levels less than 60 percent of GDP. Many countries have blown that away completely. And now investors around the world are going to take a much closer look at all the euro area countries to see whether their numbers add up.

GWEN IFILL: Is that what Angela Merkel is worried about? She’s taken a hard line against giving Greece any more support, unless they can prove that they have a plan to get themselves out of this debt.

ESWAR PRASAD: Greece has essentially benefited a great deal from being in the euro area, because they have been able to borrow a lot at relatively low interest rates.

Now, the problem is that the Greek economy is in serious trouble. They have a very high level of spending, not much tax revenues coming in. They have a labor market that is not working very well. They have a huge and bloated public sector.

So, the question naturally arises in Germany, if Germany and the rest of the European Union help Greece out, is Greece going to do what is necessary to get its economy back on track, or will it simply set up a situation where the rest of Europe continues to support Greece? And that’s why Germany wants tough conditions imposed on Greece.

GWEN IFILL: And there are some politics involved in Germany as well, because they’re having their own financial stresses.

What effect does this have on the U.S. dollar?

ESWAR PRASAD: So, this is likely to in fact prop up the U.S. dollar, because what happens is that this crisis is going to create a certain amount of concern in investors’ minds about debt issued by emerging markets and also the small industrial countries.

And the safe haven in the U.S. — in the world still remains the U.S. dollar. So, any time there is concern about investments abroad, money starts flowing in to the U.S., because the U.S. government bonds are still considered the safest instruments in the world, despite the high and rising levels of U.S. debt.

So, as money comes into the U.S., it keeps U.S. interest rates low, helps us finance our deficit more easily. But it’s going to push up the U.S. exchange rate and make the dollar much stronger relative to the euro and other currencies.

GWEN IFILL: So, that’s good news if you’re a tourist going to Europe, but it’s not necessarily bad news if you’re a U.S. exporter.

ESWAR PRASAD: That’s exactly right.

This is going to implications for the U.S. recovery, because it’s going to make imports cheaper, which means that we might import more. It is going to make exports less competitive abroad. So, the possibility that we can use exports in order to generate some employment is not going to work out very well.

So, this is not necessarily a plus. But, on the other hand, it will keep interest rates low in the U.S., because now that there is this money coming in, and most of this money is going to go towards U.S. treasury bonds, because those are considered safe and liquid, so at least we will have relatively low interest rates. And that will help. So, the net effect is hard to tell.

GWEN IFILL: There’s a big meeting of the IMF coming up that everyone is waiting to see whether there will be an announcement made of a Greece rescue — Greek rescue plan.

Does Greece have, as far as you know, a plan that it’s going to present about — that it can use to convince people, yes, we can get out of this debt, and you should help us?

ESWAR PRASAD: It’s going to be very hard, because, already, we have seen the effects of the Greek government trying to impose any sort of austerity measures.

You have people out on the streets. You have a number of strikes. So, it is going to be very difficult, given the size of the public sector and the sort of benefits that public sector employees get, to pull them back, because there is a sense on the Greek street that, effectively, this problem is not caused by them, but by the Greek government’s ineptness, and also by speculators and so on.

The reality is that Greece has been living beyond its means, and they’re going to have to cut back. So, the big question is whether Greece can come up with a credible plan that they can sell to their public and that will convince markets that they have got it right.

The IMF will impose conditions over a three-year period with very specific benchmarks about what Greece needs to do. Whether they can do it, I doubt, and I think the markets doubt as well.

GWEN IFILL: OK. And maybe that is what we’re seeing today.

Eswar Prasad, thank you so much for helping us.

ESWAR PRASAD: My pleasure.