Greece's Insolvency Has Eurozone Investors Panicking

European officials are struggling over a solution to a government debt crisis that's affected the European Union for nearly two years. The biggest source of panic is still Greece's government finances. But there are clouds over other countries as well — like Italy and Spain. Zanny Minton Beddoes of The Economist talks to Steve Inskeep about the financial crisis in the eurozone.

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STEVE INSKEEP, host: Now the downgrade of the French banks credit rating comes as European leaders continue to struggle for a solution to the debt crisis. It has hung over the European Union like a cloud for almost two years now.

We talked about the crisis with Zanny Minton Beddoes, who has one of those really great job titles, economist editor of The Economist.

ZANNY MINTON BEDDOES: Greece is insolvent. Greece is unable to pay its debt burden and no one in Europe was willing to acknowledge that. And so there was never any serious restructuring of Greece's debt. But I think the bigger problem in Europe is that the uncertainty of how Greece has been dealt with has caused investors to reassess the European's, kind of, commitment to their sovereign debt. They're questioning whether there will be defaults, kind of, across the eurozone.

INSKEEP: Mm-hmm.

BEDDOES: And since the last time we spoke, the big difference has been that the crisis has moved away from Greece to the really core parts of Europe and Italy particularly. And so you have two separate things going on now in the eurozone. You have genuine insolvency in a country like Greece, and you have panic that the rules have changed in a country like Italy.

INSKEEP: Okay, let's talk about Italy then. Because, of course, in recent weeks the European Central Bank has intervened and said we're going to buy Italian bonds - that will increase the demand for Italian bonds, it'll keep the interest rates down, it really ought to reassure investors that they're not going to get stuck with these bonds - that the European Central Bank will buy them. Why has that not worked?

JIM HERTLING: Because they haven't done it with enough force and with enough conviction. Which gets me to the, sort of, what I think is a central problem in Europe right now, which is - and its basically to do with Germany, because Germany is the main policy driver in Europe.

INSKEEP: And they've got the money and the population, in their view.

BEDDOES: Absolutely. And the German view is that they want governments across the board to tighten their budgets drastically. Now that has two consequences. The fact is that in the short term it means that the economies are weaker, collectively you're probably going to push the area into recession.

INSKEEP: When you choke off government spending, you may end up with fewer people working and that hurts the economy.

BEDDOES: Exactly. And that then makes the debt dynamics look much worse. And so that, of course, freaks out investors even more. And so you fuel the panic. And so, not surprisingly, people are just getting out of the debt of the peripheral economy. Why would you hold Italian debt with all these uncertainties? And it sounds hyperbolic, but you really do have a full-on market panic in Europe, along the same lines as we had in 2008. And yet we don't have that very clear policy response that we had in 2008, where the Fed and the government came in and said we want unlimited firepower and we will deal with. Instead, you have the people with the firepower in Europe saying no, we don't really want to do this and the politicians aren't able to come up with any other response.

INSKEEP: If you have a financial crisis, which typically can take years to clean up, and if you have this smuggling through that you're forecasting, which might stretch it out even more years, does that increase the risk of damaging the U.S. economy in the years to come?

BEDDOES: Certainly it does. I think the U.S. economy is not immune to what goes on in Europe. I think if we had a breakup of the eurozone or a splintering of the euro zone, I think it really is like, you know, breaking eggs and making an omelet. It's one thing to create a single currency. It's not so simple, in fact, it's extremely hard, to uncreated it. If that happened I think there would be chaos in Europe, there would be recession, possibly depression. The U.S., its direct financial exposure maybe becoming ever more limited, as U.S. money market funds moved out fast. But in a world of globally integrated financial market, it's just pie in the sky to think that the U.S. would be not affected and not affected quite hard. So I think it matters enormously to the U.S. It matters to the whole world economy.

INSKEEP: Zanny Minton Beddoes is economics editor of The Economist. Thanks for coming by again.

BEDDOES: Thank you.

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