The Domino Theory in Europe

A default of Greek debt could cause a cascade of the failure of $500 billion of bonds. Greece has obligations of roughly that size. However, a default on one portion of those obligations does not necessarily mean a default on all of it, particularly paper that is not due for a number of years. Some negotiated settlement is likely. Greece cannot afford to become completely financially isolated from the rest of the world, although it must be acknowledged that there is a small chance of that.

When it comes to Europe’s finances, the domino theory suggests that a rejection of austerity by Greece and a partial default on its obligations means similar problems in Spain, Portugal, Ireland and maybe eventually Italy. But EU leaders and the International Monetary Fund have a great deal of say in whether that will happen. A facility of nearly $1 trillion soon will be in place for bailouts, in addition to IMF funds. Some of this money might be lent to troubled governments on favorable terms to show that the region is serious about rescuing weak members. And there is discussion of taking the pressure off of Spain and Portugal as they wrestle with deficits and unemployment. So far, Germany has rejected this kind of plan. That could change if it sees Europe falling apart financially, which would jeopardize much of its ability to trade in the region on favorable terms.

It probably will take only a few short months for EU leadership to decide whether it can cordon off what might be a Greek disaster. If the leadership decides to aggressively provide aid to weak nations and give them some modest ground on which to bring down unemployment and cut government costs more slowly than they have to now, the domino theory can be proven wrong.

Douglas A. McIntyre