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TEN Exclusive: What is the “Contagion Effect”?

When analysts talk about the contagion effect that can be spread through Europe and the rest of the world, what do they mean? How can a little economy like Greece send the worlds markets into a tailspin and stunt growth on a global scale? The reason can be explained fairly easily.

When a country issues debt it is basically making a promise to pay back the money with interest over a given period of time. In the case of Greece, the possibility exists that they won’t make good on their promise. In the eyes of some, that makes them a liar. When one liar is found to exist it makes one wonder how many other liars are out there. When these thoughts exist in the investors mind it lends to a less credible outlook on the rest of the countries in the European Union. What if they are lying? Am I better off putting my money to work somewhere safer? To curb some of this negativity other countries will find it necessary to offer higher rates of return on their debt to attract the same investors they had previous to the Greek problem. As they agree to pay higher rates their economies suffer and a domino effect is put in place.

In an attempt to safeguard the smaller economies, thus protecting the larger ones, the European Union established a one-trillion dollar “trust fund” to back the debt of the worst countries hit. Unfortunately, this went hand in hand with demands that these countries take “severe” measures to rectify their ailing economies. Tax hikes as well as spending cuts will be on the agenda for all of them. This is only going to lead to less growth for these countries and a greater possibility of default. In the end, it will most likely not be enough to save a few. They will likely have to abandon the euro and start the long and arduous journey back from their current depths.

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