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Industry Insight: Greece's financial crisis hits home

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The deteriorating economic situation in Greece is largely responsible for the recent sell-off in global markets. Markets worldwide are paying close attention to economic conditions in Europe, and Wall Street is reacting to the televised images of riots and protests as Greece attempts to stabilize its situation.

So it’s no surprise that skittish markets temporarily plunged upon the latest developments in Europe. World markets have been concerned about the state of some unstable European economies – namely Greece, Spain, Portugal, Italy and Ireland – whose national debts continue to hamper their full participation in the global recovery.

Greek economic woes
After years of deficit spending and continued borrowing with no significant success in raising revenues, the Greek economy was in a precarious position when the economic downturn hit during 2008 and 2009. Its national debt now outpaces its gross domestic product by more than 12 percent.

Greece’s debt was recently downgraded to junk status, which indicates that foreign investors have little confidence in the strength of the Greek economy. Pension funds and other investors are unable – except at prohibitively expensive distressed interest rates – to buy the country’s bonds, eliminating a key source of funding for Greece. The prime minister is attempting to address the crisis by implementing tax increases and steep spending cuts, leading to civil unrest.

European Union leaders worked with the International Monetary Fund to structure a solution and act quickly. The EU announced a bailout package of nearly $1 trillion on May 9 in an effort to stabilize the situation and bolster investor confidence. This speedy, unified and bold reaction came after the European nations had taken earlier criticism for being tentative when early signs of the crisis appeared.

The central banks of Canada, Britain and Switzerland, together with the U.S. Federal Reserve and the European Central Bank, moved to establish swap lines that are expected to provide more liquidity to the European banks and money markets. These moves indicate that the crisis is being monitored – in Europe as well as in North America – to keep the situation from spreading to other debt-ridden economies.

Consumer implications
The crisis has hit euro-dominated companies hard, so investments in firms or pensions with significant exposure to these companies have suffered. From a broader perspective, this episode has hurt the credibility of the euro, and its value compared to the U.S. dollar has fallen. American travelers will see their dollars go further when they travel to Europe. Conversely, European travelers to the United States will realize less buying power.

Markets will be watching the developments in Europe closely in the near future to see if fears of the debt crisis in Greece could spread to other debt-saddled countries. Greek debt to European banks totals around $200 billion; if the crisis extends to Spain and its $800 billion bank exposure, the situation will be seen as more serious.

America’s deficit
This crisis has spawned a new sense of urgency in discussing the growing deficits in other countries, including the United States, whose deficit reached $1.4 trillion in 2009. The U.S. economy is diverse and robust compared to Greece’s. Although the U.S. economy is now growing again, markets are paying closer attention to the U.S. federal deficit.

The crisis in Greece has leaders around the world taking notice.

Nations that take significant steps to rein in deficits will provide a more solid footing for their economies, and in the process will show investors that the recovery we have seen since the market lows in March 2009 can continue, even with periodic corrections.

Paula Dougherty, CFP, ChFC, CLU, is a senior financial adviser with Dougherty & Associates, Ameriprise Financial Inc. in Springfield. She may be reached at paula.j.dougherty@ampf.com.[[In-content Ad]]

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