If you’re an investor, you may have noticed that the market took a bit of a dive today. This is the first time in all of 2015 that the S&P 500 has dipped by more than two percentage points in one day. The problem comes from across the Atlantic.
The average investor might not know a whole lot of precise information about what’s been happening there since The Great Recession, but that doesn’t mean they aren’t well aware of the strife.
Major Deadline on Tuesday
Greece is facing a deadline tomorrow that has serious implications for the country’s future. They are scheduled to pay back €1.6 billion to the IMF and they need a loan from the ECB to make this happen. However, the ECB has been giving loans to Greece since 2010, and each loan came with a set of specified conditions for cutting spending and raising taxes. These austerity measures have caused a lot of pain for the Greek people and led to civil unrest.
Earlier this year, a member of a leftwing party called SYRIZA replaced the prime minister who accepted these loans and accepted these stringent austerity measures. Alexis Tsipras, the SYRIZA candidate who is currently Prime Minister, was elected based on his pledge to fight austerity and, to some extent, he’s kept his promise. But at what cost?
Prime Minister Tsipras called for an extensionof this June 30th deadline because he wanted to put the terms and conditions of the new loan to a July 5th referendum for the people to vote on. The IMF rejected this request and, so far, Greece has not accepted the new loan’s terms and conditions. If they fail to do so, Greece will default tomorrow.
This has turned into a game of international economics chicken. Will the IMF cave and give the Greeks an extension or will Tsipras accept the terms and conditions of the new loan? Both parties have a lot to lose if they don’t comply, but neither party wants to concede.
The IMF and ECB don’t want to grant the extension to Greece because it sends the wrong message to countries like Italy, Spain, and Portugal who have accepted loans and held to the strict austerity measures put in place. Greece doesn’t want to accept the terms of the loan because Tsipras specifically ran on an anti-austerity platform and because it’s an “insult to the Greek people”…whatever that means. He doesn’t want to look like a hypocrite and he fears the social unrest that might follow.
Rating Agencies Losing Faith
Right now, the international financial community doesn’t appear to have a lot of faith that Greece will pull itself together. The S&P has downgraded Greek bonds to CCC- and said there is a 50% chance Greece will default on its debt. They say that there’s a similar chance that Greece exits the Eurozone. If Greece does default on their debt, there will be consequences that extend all over the world, even here in the United States.
Europe Loses a Lot of Money
European countries, as well as the IMF, don’t want to see Greece default because they will lose a lot of money. Right now, Greece has roughly €243 billion in debt. €38.7 billion of that is in the hands of private investors with the rest owned by the IMF, European Central Bank, and the countries of Germany, France, Italy, and Spain. Since nearly all of Greece’s debt is owned by Europe, they will lose a lot in the event of a default. The best-case scenario in the case of a default is a debt-restructuring deal.
There are also fears of a contagion effect, but this seems unlikely. While Greece defaulting would create a disturbance in the market, many people in Europe have been preparing for this day. For that reason, the European Central Bank is confident that any contagion effects will be very limited. Greece has also limited the contagion effect domestically by putting strict capital controls on deposit withdrawals and closing banks across the country for the week. Individuals are only allowed to withdraw sixty euros per day.
Financial Markets Are Losers, Too
Financial markets all over the world have been the real losers today. In America, the Dow Jones and the S&P 500 were both down 2%. The NASDAQ was down 2.4%. The Euro Stoxx 50 Index was down 4.2% and the FTSE in London was down two percent. The Nikkei Index was down 2.9%. The Shanghai Composite Index was down 3.3%.
Unsurprisingly, the price of Greek bonds plummeted with yield on two-year bonds rising to 34%. To give some perspective, the American two-year treasuries have a yield of 0.6%.
How About America?
The United States is largely shielded from the debt crisis in Greece. We have none of their toxic debt on our balance sheet and they account for less than 1% of our total international trade. A financial crisis in Greece would only affect the United States if there were a contagion effect that spreads through Europe.
While the ECB and Prime Ministers Francois Hollande and Angela Merkel might insist that a contagion effect will not happen, the United States can’t just take their word for it. We have a vested interest in making sure Greece either accepts the deal and stays solvent or keeps their financial crisis contained within their borders. Therefore, chairman of the Federal Reserve Janet Yellen has been keeping a close eye on the situation in Greece as well as offering advice to ECB and IMF leaders.
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