At the beginning of the week, Greek Prime Minister George Papandreou caused tremors in markets worldwide with his announcement that he wanted a national referendum to decide whether the country will accept another bailout.
The bailout terms themselves were highly debated by other European nations like Germany and France, and these European Union countries only reached an agreement last week, to the great relief of the global community. (Here’s what went down.)
But then, earlier this week, Papandreou called for a referendum, basically a vote on whether Greeks are willing to go through more austerity cuts in order to stay in the euro zone at all. For obvious reasons—the Greek people have recently experienced civil service pay cuts, pension cuts, higher taxes and privatization of some national institutions like utility services—the Greek prime minister isn’t so popular at home.
The move for a referendum was meant to strengthen his public position ahead of a vote of confidence in his government today, but turning the decision on the bailout over to the people came with a big risk: There would be a real chance they'd reject it.
According to opinion polls, most Greek voters think the bailout is a bad deal; nearly 60% of the population thinks the package is potentially negative. Although the package would give the Greek government an additional $182 billion, the austerity measures are really unpopular.
But Then There Was Chaos ...
This controversial move for a referendum rattled global markets, other European leaders and the already-tenuous political stability in Greece. It sparked a rebellion within Prime Minister Papandreou's own party, brought up questions about whether Greece would stay in the euro zone and raised alarmist doubts about the potential collapse of the euro currency itself.
By yesterday morning, there was talk of Prime Minister Papandreou resigning, and by the times markets closed, he had shelved the whole referendum. Meanwhile, the Group of 20 leading economies in the world gathered in France to discuss ways to safeguard the euro and prevent a global meltdown.
The future of his government remains in flux, as the confidence vote is still planned for today.
What Would've Happened If the Greeks Refused the Bailout?
The short answer is that Greece would probably face default, which would constitute the largest sovereign debt default in history. If that happened, the ripples would be felt well beyond Greece.
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Countries and worldwide markets are fiercely interrelated. Crises spread quickly in our modern economy, and other countries and private debtors would suffer severely if Greece actually defaulted on its debts. For more on how Greece—and Europe as a whole—got into this mess and how it affects the world at large, read this.
Already, the indecision in Greece brought Italian bonds to an all-time high for the euro in terms of its risk measure. That raised the country’s borrowing cost a ton, to levels that were unsustainable for Ireland and Portugal. While Italy and Greece are separate countries, Italy holds a lot of Greek debt, so increased fears about one country defaulting could cause a domino effect for others.
Where the Ripple Effect Will Lead Us
In addition to chaos in the markets, the referendum may have also hurt some of the bailout terms themselves: Potential investors in Europe's bailout fund, like China, are now holding back from making any decisions until Greece's future is clearer. Plus, last week's agreement tentatively called for banks to willingly absolve Greece of 50% of its debt. Now, however, BNP Paribas, the largest global banking group in the world, has said in a note to clients that the call for referendum has "shredded [the breakthrough deal] irretrievably."
As we’ve seen, the markets have been experiencing more drastic ups and downs on a regular basis now than ever before. (Here’s what we had to say about that.) The economy is different than it used to be, so we think economic systems and governments will have to no choice but to shift course to keep pace.
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