28 July 2011.
On paper at least, few would consider Greece to be a systemically significant economy. Yet today, the country is at the centre of a crisis that threatens to engulf the entire European Union. But the case of Greece is not unique. In 1997, another relatively small economy, Thailand, was at the epicentre of the Asian Financial Crisis. How can small economies cause such big problems? By Kemal Derviş.
WASHINGTON, DC – Greece’s GDP, at about $300 billion, represents approximately 0.5% of world output. Its $470 billion public debt is very large relative to the Greek economy’s size, but less than 1% of global debt – and less than half is held by private banks (mainly Greek). Barclays Capital estimates that only a few globally significant foreign banks hold close to 10% of their Tier 1 capital in Greek government bonds, with the majority holding much less.
So, at least on paper, Greece should not be a systemically important economy. Yet there are several reasons why the Greek crisis is having substantial spillover effects. Moreover, Greece is not alone in this respect.
First, in the Greek case, there is the fear of contagion to other distressed European economies, such as Portugal and Ireland, or even Spain and Italy. There are also substantial investments by American money-market funds in instruments issued by some of the exposed banks.
Then there are various derivatives, such as credit-default swaps, through which banks holding Greek debt have insured themselves against non-payment. If CDSs are concentrated in particular financial institutions, these institutions could be at risk – more so than the primary purchasers of Greek debt themselves. But no one knows who is holding how much of these derivatives, or whether they reduce or magnify the risk, because CDSs are not transparently traded on open exchanges.
Finally, Greece’s difficulties imply problems for managing the euro, as well as possible disorderly behaviour in foreign-exchange markets, which threaten to augment uncertainty and negatively influence the already-weakening global recovery. Clearly, the world economy has a large stake in Greece’s recovery.
In the same vein, consider a completely different case, that of Yemen. Greece and Yemen have no relevant similarities, except the contrast between their size and possible spillover effects. Yemen’s GDP is only 10% the size of Greece’s, representing 0.05% of global output, and its economy is not significantly linked to the international financial system.
But Yemen’s population is close to that of Saudi Arabia, and its border is very hard to control. Chaos in Yemen, coupled with the growing strength of extremists, could seriously destabilize Saudi Arabia and threaten oil production. In that case, the price of oil could shoot up to $150 a barrel or more, dealing a heavy blow to the global economy.
One can find other examples of this kind. Recall that the 1997 Asian crisis started in Thailand – again, not a large economy. The strong trade, financial, and natural-resource-related interconnections that have developed in the world economy turn many otherwise small countries, or problems, into global systemic risks.