Greece is a small country, 6,000 miles away with only 11 million people. How can what happens to Greece have any impact on the United States?
The answer lies in the concept of globalization, which means that economies around the world are now interconnected, such that events in far off places have impacts here at home.
Greece borrowed a lot of money, but it didn’t borrow from the Greek people. Instead, it borrowed from foreigners, which in many cases were European banks, who lent the money to Greece by buying Greek government bonds. Today, the Greeks can’t pay the money back, and it appears inevitable that they will default on the bonds.
The bonds are assets of the European banks, and part of their “capital.” If those bonds suddenly become worthless, or lose a lot of their value, the value of the capital of the banks shrinks. That can have two consequences. In severe cases, it could result in the failure of some European banks unless they can recapitalize, which means raise new capital to cover the capital that has been lost. More important, even for those banks that survive, they can only make loans equal to a multiple of the value of the capital they hold. If their capital shrinks in value, they can make fewer loans and credit dries up. If that happens, economies tend to slow down or fall into recession. This could have a major impact on the European economy, especially if events in Greece are repeated in other nations such as Portugal, Ireland, Italy or Spain.
Moreover, American banks and other American financial institutions, such as money market funds, have lent money to many of the European banks. If the credit quality of the European banks falls, those loans in turn could lose value.
The connections don’t end there. Many major American companies are international companies that derive a substantial portion of their incomes from overseas operations, often in Europe. In addition, many U.S. companies are major exporters to European markets. If the European economy stagnates, the income of these U.S. companies could fall. They will have less money for new business investment, which could adversely effect both growth in the United States and the U.S. stock market.
These connections, and the impacts that nations have on each other, are amplified by the fact we are all lending and borrowing money from each other -- Greece borrows from European banks, European banks borrow from American banks, America borrows from foreigners all over the world (especially China), and so on. This borrowing is called leverage, and leverage often makes what would otherwise be small events very large.
If not controlled, it can become a dangerous spiral. Countries end up lending money to other countries so that those other countries can buy goods and services from the lending countries. But now the countries doing the lending are dependent on the other countries’ economic well-being if they are ever going to be paid back. Too often, the countries that have borrowed the money can only pay it back if other countries are willing to lend them even more money. Countries do lend them even more money because if they don’t the countries that borrowed the money will default on their loans and the countries who have lent the money will never be paid back. So it continues over and over. Such has been the case with Greece.