NEW YORK (The Street) — Should the U.S. and the rest of the world really care that Greece is standing on the brink of defaulting on its debt and possibly abandoning the euro? After all, its economy amounts to just 2% of the whole Eurozone.
If it does tumble out of the euro, Greece’s GDP will probably shrink by as much as 20% to 30% as its access to international credit evaporates and its international trade disintegrates, but it is unlikely to have much of a direct impact on the U.S. or the rest of the world economy.
To be sure, people have compared Grexit with the collapse of Lehman Brothers in 2008, which triggered a financial tsunami, with stock exchanges plunging around the world, a global recession, unemployment rocketing and market confidence shaken to its very core — the world is still recovering from that shock.
Must Read: Eurozone Economy Strengthens, Helping EU’s Bargaining Position With Greece
The knock-on, domino effect of Greece’s default could well hurt the U.S. and the world economy, though. Because if Greece does fall out of the euro, the whole eurozone is under threat, and if that collapses then the U.S. and the rest of the world could be in for a bumpy ride.
If Greece is allowed to fall out of the eurozone, the financial markets will get jittery. The smart money has already pulled out of Greece, but if it defaults, investors will start fleeing other debt-ridden members like Spain and Portugal, fearing something similar, perhaps plunging their fragile economies back toward recession.
The value of the euro will plummet and the European Central Bank would have to increase interest rates, putting a further brake on the Eurozone economy when it is still struggling to recover from the financial crisis as its GDP bumps along at less than 1% annual growth.
This would harm U.S. exports. Europe is the U.S.’s second biggest trading partner, with the economic activity between them accounting for one-third of total goods and services traded in the world. Exports from the U.S. to Europe amount to around $470 billion a year.
The ECB has brought in measures to buy up periphery bonds in an attempt to limit the spread of any financial contagion from Greece’s exit in theory. But there will be doubts in the markets over Spain and Portugal’s continued participation in the euro and fears of contagion from Greece’s plunging economy. After the IMF and the ECB, foreign banks have about $46 billion of exposure to Greece, with Spain and Portugal two of Greece’s bigger creditors, so they will feel the hard landing if Greece crashed out of the euro and returned to the drachma.
Spain in particular has a sizable left-wing populist party, Podemos, which is similar to Greece’s Syriza. It has been winning support after swingeing austerity policies were implemented to meet its bail-out conditions; it may garner further public support if the Spanish public see Greece defying the IMF and the ECB and if they do eventually turn out to be better off outside.
Everybody agrees the short-term effect of leaving the euro will be catastrophic for the Greek economy and its people, but in the long term some economists believe Greece would be better off outside a currency union it should never have joined in the first place, and it would not have had to pay off all of its onerous debts.