How the financial crisis in Greece could spread to Australia: Maley

We should all be watching the unfolding Greek drama with close interest, because how it plays out will ultimately affect how much we pay on our own home loans.

Last night, the pressures on Greece appeared to ease after the European Commission accepted the country’s ambitious plans to slash its budget deficit to below 3% of gross domestic product by 2012, from around 13% at present.

But the warm glow from the Brussels blessing vanished as soon as Greece’s largest union announced plans to hold a general strike later this month to protest against the savage government cuts.

Once again, investors fretted that the Greek government’s resolve to implement tough measures would wilt in the face of a strong public backlash.

There are also worrying signs that the deep-rooted anxiety over Greece’s financial woes is already spreading.

Portuguese bonds were sold off heavily overnight, pushing up its long-term interest rates. Portugal is generally considered the second weakest economy in the eurozone after Greece, with a budget deficit of close to 7% of GDP.

Unless there is a speedy resolution in Greece, there are fears this contagion will soon spread to Spain, Irish and Italian bonds.

But it’s clear there’s a huge political rift within the European Union over how to deal with the Greek situation. Germany, in particular, appears disinclined to bankroll its free-spending southern neighbours.

Last week, Germany’s economy minister told parliament there would be “no bail-outs” for struggling eurozone economies, and that each country must to solve its own problems.

But these stern words were brought into question by a report in France’s Le Monde newspaper that French and German officials were discussing a rescue plan for Greece, in a bid to maintain the credibility of the eurozone.

What’s more, although German and French governments won’t like being seen to hand over large wads of cash to other countries at a time when they’re implementing tight budget measures in their own economy, they may have little choice.

French and German banks have huge exposures to Greek, Spanish and Portuguese debt.

Without European Union intervention, Greece, Portugal and Spain will inevitably face higher interest rates, which would likely cause widespread business collapses and defaults. French and German banks would face massive losses on their souring loans.

But the time for EU procrastination is running out. Growing anxiety means that the Greek government is facing sharply higher interest costs now and at a time that it is struggling to slash its budget deficits.

Athens has been relying on short-term debt to plug its budget deficits. The country will have to find 53 billion euro ($83.5 billion) in funding this year, mostly in the first half. Investors are very unlikely to stump up with the cash unless there is much more clarity over Greece’s future.

And there is an additional risk that wealthy Greeks might take fright and start shifting their money into, say, German or Swiss banks. This could trigger a crisis in the Greek banking system, similar to Mexico’s Tequila Crisis in 1994-95.

In the meantime, the growing focus on government deficits is fuelling bond market anxiety.

There is a risk that fears over big spending governments will spread outside the eurozone, and infect the credibility of the United States and Japan. As a result, global bond yields would rise sharply.

Australia would not be immune, either. Even though our government has been running comparatively responsible economic policies, we would face higher interest rates because our big banks raise a lot of their funding in offshore markets. A jump in those rates would inevitably flow through to local home loan and business borrowers.

This article first appeared on Business Spectator.