{"id":568737,"date":"2010-05-18T09:35:14","date_gmt":"2010-05-18T13:35:14","guid":{"rendered":"tag:theatlantic.com,2010-05-18:mt-56858"},"modified":"2010-05-18T09:35:14","modified_gmt":"2010-05-18T13:35:14","slug":"what-is-the-contagion-effect","status":"publish","type":"post","link":"https:\/\/mereja.media\/index\/568737","title":{"rendered":"What is the 'Contagion Effect'?"},"content":{"rendered":"

Greece’s debt crisis won’t stay in Greece. It’s quickly becoming Europe’s nightmare. Newspapers often refer to Greece’s inability to balance its own checkbook as a kind of “contagion effect” that could spread through the continent. How can a nation’s debt be like a disease?<\/p>\n

First, let’s think about debt. A country’s debt — or “sovereign debt” — is the accumulation of past deficits. It equals the total sum of promises to pay back the bonds, or loans, it sells to investors in order to run the country. If the country pays back the bonds on time, hunky dory. If it cannot, the country is in default.<\/p>\n

If debt is a promise, default is an acknowledgment that the country was lying, and the “contagion effect” is a paranoia that there are more liars. Here’s how it works: one country gets into trouble — usually with some combination of high deficits, high debt, and weak growth — and becomes at risk of defaulting, or breaking its promise to pay off the whole bond. So investors look around to identify more trouble, assuming that countries with similar problems will suffer similar fates. Think of it as a kind of fiscal discrimination, or profiling. It doesn’t matter if you’re at risk of default. It matters that you look like some other country that is guilty of gross financial recklessness.<\/p>\n

Suddenly, these targets of fiscal profiling (Portugal, Italy, Ireland, and Spain… for now) face investor discrimination and lower demand for their debt. So they raise their interest rates to attract buyers. But those higher interest rates only make it harder to pay off their debt. The vicious cycle is self-fulfilling, like a “reverse-Tinker Bell effect”: if investors don’t believe in you, your financial credibility disappears.<\/p>\n

How do you stop the contagion from spreading? Remember, contagion is a loss of trust. So its cure could be a guarantee. Here, another comparison is useful. In the Great Depression, when the banks looked unhealthy, depositors rushed to withdraw their money, depleting many banks’ cash reserves and leading to their failure. (That was a kind of contagion, too.) So to prevent future “bank runs” the federal government created the Federal Deposit Insurance Corporation to reassure Americans that their money was safe.<\/p>\n

That’s exactly what the European Union is trying to do. It has created a trillion-dollar emergency fund to stand behind Greek debt in exchange for draconian requirements for Greece to raise taxes and cut spending. This will delay, but not dodge, a default in Greece. An austerity shock will shrink the Greek economy, depress income, hurt tax revenues and increase the country’s debt burden as a percentage of GDP (a key indicator for investors). The emergency fund might be big enough to solve an isolated Greek crisis, but it is not big enough to save Greece and<\/i> inoculate the contagion that could spread to larger countries. In other words, the Eurozone is not strong enough to back up all of its weak member states’ endangered promises. As a result, Greece will almost certainly default on its debt and might face the possibility of dropping the euro. <\/p>\n



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\nGreece<\/a> – United States<\/a> – Federal Deposit Insurance Corporation<\/a> – Great Depression<\/a> – Gross domestic product<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Greece’s debt crisis won’t stay in Greece. It’s quickly becoming Europe’s nightmare. Newspapers often refer to Greece’s inability to balance its own checkbook as a kind of “contagion effect” that could spread through the continent. How can a nation’s debt be like a disease? First, let’s think about debt. A country’s debt — or “sovereign […]<\/p>\n","protected":false},"author":1534,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-568737","post","type-post","status-publish","format-standard","hentry","category-news"],"_links":{"self":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/568737","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/users\/1534"}],"replies":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/comments?post=568737"}],"version-history":[{"count":0,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/568737\/revisions"}],"wp:attachment":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/media?parent=568737"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/categories?post=568737"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/tags?post=568737"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}