Fears mount about European breakup as leaders threaten Greece

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European officials are stepping up pressure on Greeks, warning the country that if Athens were to depart from the common currency, Spain and Italy could well be the next dominoes to fall in Europe’s widening financial crisis.

Greek voters had just ousted the government which planned deeper austerity measures in return for a financial lifeline from the European Union, but they will have to return to the voting booth this June as the winning parties have failed to form a Greek government.

European officials are taking the opportunity in the pause between governments to try to steer Greeks back on to the austerity path, warning of dire consequences if they don’t.

The comments are serving to heighten fears further about the possible consequences of a wider breakup of the Eurozone should the Greeks exit the monetary union.

Italy and Spain are the next possible followers in Greece’s wake. Already investors are backing away from Spain’s government debt, raising the country’s borrowing costs to levels close to that of Greece. Fresh economic data is showing that the Spanish economy is shrinking.

U.S. investors are reacting to the news with increased nervousness. The Dow Jones industrial average has been falling consistently for more than a week, and U.S. banking giant JPMorgan Chase sent another ripple of worries through the market May 10 when it said it had lost at least $2 billion in a failed attempt to hedge against European volatility.

Depositors pulled another $900 million out of Greek banks on Wednesday, extending a capital flight that could bring down Greece’s banking system. The big worry is that fear will spread among depositors in other countries like Spain where the banking system is already under pressure.

Analysts are loathe to even consider the possible repercussions of a Greek departure from the euro. Replacing the euro with a new, devalued currency would wipe out much of the remaining assets on Greek bank books.

A return to the pre-euro Drachma – or any new Greek currency – would be enormously devalued, by some estimates as much as half the value of a euro. While that would help Greece’s economy get back on a growth path, Greek households and businesses would bear the immediate pain. Imported goods like oil would cost twice as much, and repayment terms on loans would become staggering.

The scenario could play out in Spain and Italy as Greece paves the way for an exit strategy. Meanwhile, government austerity measures imposed on weaker economies are driving them deeper into recession. Some see the emerging developments as simply stage two of the global financial crisis.

Image Source Wikimedia Commons

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