Why Greek Debt Matters

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Yesterday, the stock market plunged about 180 Dow points. So we got headlines like this one from CNBC: Stocks end day sharply lower amid Greek fears. Here’s the first sentence: “Stocks fell sharply Wednesday, giving up all of their gains from the day before, as investors became increasingly concerned about the worsening debt crisis in Greece.”

If you invest in stocks through a retirement plan at work, you’re (hopefully) aware that stocks involve risk. You can wrap your mind around the fact that if the U.S. economy is hurting, that’s probably bad for stocks.

But a debt crisis in Greece? How are you supposed to factor that into the equation? Your 401(k) shouldn’t tank because a small country 5,000 miles away is having trouble making ends meet. Not only is Greece small and far away, in terms of the global economy, it’s an afterthought. Their entire economy equals that of Massachusetts.

What gives?

At this moment, Greece matters to the global economy for three reasons…

1. It’s part of the European Union. Because Greece is part of the European Union, it’s linked to other member nations in many ways, not the least of which is their common currency, the Euro. So when Greece has trouble paying its bills – which it’s had for more than a year now – other countries in the EU are forced to bail it out to protect their own economies and currency. Greece now owes lots of money to big banks and governments of other member countries. If it can’t pay it back, those countries and banks could lose billions. Result? Banks stop lending, require bailouts from their respective governments, and the entire European economy grinds to a halt. And while Greece may not be a huge trading partner of the United States, the European continent is. Our nation depends on exports to create jobs. A recession in Europe could send our unemployment rate up and our stock market down.

2. The crisis could spread. If one country defaults on its debt, who’s to say another won’t? If Greece reneges, investors will shy away from the debt of other weak European economies, like Spain, Italy and Ireland. Even the debt of stable countries like the U.S. might start looking riskier. And when things get risky, bond buyers demand higher interest rates: bad for struggling economies. Think of it this way: How do you think it would affect our housing market if mortgage rates suddenly went up by a percent or two?

3. Investors are looking for a reason to freak out. Even before this particular problem, the economic recovery both here and abroad was looking fragile. As I mentioned in my post last week, Investors Take Warning: Storm Clouds Gathering, there are already some serious headwinds out there, from rising unemployment to falling home prices.

When you’re in a good mood, you can take bad news in stride. But when you’re in a bad mood,the smallest thing can set you off. Greece was enduring nearly the same set of problems last March, and markets shrugged it off. Today, the sky’s not so sunny and investors are less tolerant.

Is it the end of the world (economy)?

Let’s not kid ourselves: If Greece defaults on its debt, the shock to the global economy will be severe and the repercussions for investments everywhere will be unpleasant. That’s far from a sure thing at this point, but something to keep an eye on.

Bottom line? It may not seem fair that issues in one small European country can impact your investments half a world away. But that’s one of the unintended consequences when the economy goes global: Get used to it.