Sovereign Debt Contagion In Eurozone

This article is about the contagion of the sovereign debt crisis in Europe. Initially countries like Greece, Portugal and Ireland had to pay a risk premium to borrow funds to turnover their debt as bonds matured. The risk premium is the spread between the interest rate that Germany pays to turnover its debt compared with the interest rate other countries must pay. Countries at the core of the Euro zone are now paying a risk premium compared with less risky German debt. If these countries need to borrow money to deal with problems in their banks, higher interest rates will limit their ability to deal with the problem.

A good point is also made in this article about the proximate cause of the problems in the peripheral countries. They all ran large trade deficits which had to be funded by borrowing. Cross border borrowing from other banks in the Euro zone to fund the trade deficits was facilitated by the perception that the loans were implicitly guaranteed, and therefore, risk free. Problems in Greece changed this dynamic. The banks that loaned money to Greece are at risk and they are also at risk for their loans to the rest of the Euro zone.

The difficulty of dealing with the crisis in the Euro zone has made it obvious that politically difficult changes will have to made to integrate the Euro zone economically in order to preserve the common currency.