Greece's Ripples Spread Wide

The most important potential benefactor, Germany, induced its citizens to surrender their stable deutschemark for the new euro by promising they would never have to fund the profligacy of their fellow euro-zone members. Voters say they will hold German Chancellor Angela Merkel to her predecessors' promises. Any inclination she might have to fund a bailout is reduced by Greek reluctance to accept outside (read, German) supervision of its future budgets. Having once been occupied by Germans, the Greeks are unhappy seeing Ms. Merkel's tanks on their lawn—symbolic tanks only, of course. History matters. Tragedy.

Meanwhile, it turns out that Greece, aided and abetted by Goldman Sachs and others, has sold several future revenue streams for current cash, and parked the liabilities far from the national balance sheet, while denying to European Union officials that it was engaged in any such process. Even the revenue stream from the sale of admission tickets to the Parthenon was on the block, but headlines of "Greece sells Parthenon" were too horrible for the nation's politicians to contemplate. Farce.

There's more, but it is important to resist the temptation to focus solely on Greece or the problems it creates for the inventors and fans of the single currency. It is the wider implications of this play that are important.

The first is that all sovereign balance sheets are in play. I don't know whether an overlooked volume, "Debt Defaults and Lessons from a Decade of Crises," by Federico Sturzenegger and Jeromin Zettelmeyer (from the Universidad Torcuato di Tella in Buenos Aires and the International Monetary Fund, respectively), has leapt to the top of the best-seller lists or not, but guess it hasn't. Too bad.

These economists point out, "All lending booms so far have ended in busts in which some of the beneficiaries of the preceding debt inflows defaulted or rescheduled their debts." The good news is that no western European country has defaulted since the period between the two World Wars. If history has a tendency to repeat itself, the bad news might be that "The first recorded default goes back at least to the fourth century B.C., when ten out of thirteen Greek municipalities … defaulted on loans from the Delos Temple…"

Spain's balance sheet is one of those receiving closer scrutiny since the, er, peculiarities of Greek accounting were revealed. With reason. German banks are holding some $240 billion of Spanish paper, five times their exposure to Greece, and the largest exposure to Spanish debt by any country other than the U.K., according to the Bank of International Settlements.

French banks also have a greater exposure to Spanish debt than to Greek IOUs—almost $200 million owed by Spain compared to $75 million owed to French banks by Greece. Of course, the risk of a default or some other restructuring disadvantageous to the banks is at the moment greater in the case of Greece than of Spain. And likely to remain so.

For one thing, Spain's debt-to-GDP ratio is only 54%, whereas Greece's is well above 100%. Since studies show that debt becomes a significant drag on growth in developed countries only when it reaches something like 90%, any economic recovery in Spain is likely to be more robust than a snap-back in Greece.

Not that the Spanish economy is a model of good performance. It has shrunk for seven straight months, the jobless rate is around 20%, the fiscal deficit is in double digits, and Standard & Poor's has lowered its ratings outlook to negative. But S&P apparently retains sufficient faith in Spain's planned austerity program to rate its debt double-A-plus, while Fitch and Moody's retain their triple-A ratings. Probably because of Spain's good history of fiscal management, perhaps because consumer spending recovered in the fourth quarter of last year, perhaps because the government is predicting that durable growth will return this year, investors are demanding less than a one-percentage-point premium over rock-solid German government bonds, compared with more than triple that for Greek paper.

The ripple effects of the Greek tragedy extend beyond Europe's banks. The high yields on Greek and other sovereign-debt bonds are attracting investors who otherwise stock their portfolios with corporate bonds or those of countries such as Brazil, forcing yields on those bonds up—a sort of "crowding out" of those issues. Globalization matters when money respects no borders.