If we have learned anything in the past two years, it’s that our world is interconnected more than ever before.
Countries that are close trading partners are rarely insulated from each other. In Canada we have a saying that when the US economy sneezes, Canada catches a cold.
We’ve talked extensively on the concept of counter party risk on this show.
Back in 2010, many European banks, particularly in France and Italy were on the verge of insolvency as a result of exposure to Greek sovereign debt. In the end, European and foreign investors solved the problem by lending Greece even more money. They kicked the can down the road and averted catastrophe, but didn’t really solve the problem.
Let’s put this in perspective. Greece is a tiny country, despite holding a large place in world history. The total population of Greece is only 12M people, and about 4M of them live in Athens. Compared to the population of the entire European Union, Greece is a rounding error. At the time, some of France’s largest banks were leveraged more than 30:1, meaning they held deposit reserves of 3-5%. These banks had approximately 3% of their balance sheet exposed to Greek sovereign debt which by itself would be enough to sink some of France’s largest banks.
The question is, how many other countries out there have gone through economic disruption over the past two years, are facing crushing levels of inflation, and are at increased risk of default?
The question is which country is going to run into trouble first, and then what will the cascade effect be of that counter party risk when the dominos start to fall over. Will it be Greece? Will it be the UK with debt at 345% of GDP, or maybe the republic of Ireland with debt of 700% of GDP? We are fixated on the balance sheet of the Federal Reserve. That’s important to be sure. But the next financial crisis will be the result of a weaker economy having a cascade impact on the rest of the world.
Host: Victor Menasce