Global Crisis

Interlinked Markets: Strength and Weakness

By Shlomo Maital

The head of the European Central Bank, Jean-Claude Trichet almost always speaks in understatements.  When he says “Europe is undoubtedly in the world situation since WWII, perhaps even since WWI.  The markets stopped functioning!”,  then things must be really bad.

But why?  Greece is a tiny country of only 11 m., nearly all the other 27 EU countries are larger, and Greece’s population is only 2 per cent of the EU’s 501 m. people.   Why should the downgrading of Greek Government bonds to BB (junk) status topple the euro?

The answer is found in Nelson Schwartz’s and Eric Dash’s fine reporting in yesterday’s New York Times (“Fears intensify that the euro crisis could snowball”).    There is a powerful domino effect.  One bank lends to another. One country lends to another.  And another.  Topple one domino, even a small one, and a lot of other dominos fall very quickly.  Why was Citigroup bailed out?  AIG?  Because their failure would have toppled other institutions, who would in turn topple others…and so on, and no-one knew for sure where the falling dominos would end.

According to Schwartz and Dash, Portuguese banks owe $86 b. to Spanish banks, which in turn owe $238 b. to German banks and $220 b. to French banks.  American banks, in turn, hold $200 b. of Spanish bank debt, according to the Bank of International Settlements (the Central Banks’ bank).   A great many American financial institutions have lent money to a variety of European banks and governments.  The fall in the euro, relative to the dollar, has already caused them major losses.

I doubt that anyone fully understands all the complex financial links among governments and banks worldwide.  What we do know is that they are all tightly and closely intertwined.   In normal stable times, an integrated global capital market is a powerful tool for spurring growth and credit.  In crisis-ridden unstable times, it becomes a mechanism for spreading crisis from one small corner of the world to the entire world.   That is why John Donne’s famous medieval sermon applies more powerfully than ever, today:  “Ask not for whom the bell (euro) tolls.  It tolls for thee.”