At this point, it's a given that Greece may not be able to pay off its debts, even with a big bailout from the EU and IMF. The bigger worry now is that the debt crisis is spreading to several other EU countries — and it may lead to broader economic troubles in Europe.
"Contagion has already happened," Angel Gurria, the secretary general of the OECD, told Bloomberg News today. "This is like Ebola: When you realize you have it, you have to cut your leg off to survive."
(Side note: Gurria is an economist, not a physician.)
For Gurria, the treatment is to promise Greece lots and lots of money. He doesn't say how much. But he says it has to be more than enough to keep the country going for a few months. Otherwise, the markets will just assume the default will occur a little further down the road.
That's clearly what's happening with Greece. The price of insuring Greek debt against default implies a 45% chance that the country will default within five years, figures in the WSJ suggest.
But, as Germany debates whether and how it should contribute to a Greek bailout, investors are also worried that Portugal, Ireland and Spain may soon stumble in paying back their loans.
This creates a positive feedback loop: Nervous investors charge higher interest. That leaves countries further in debt, which in turn makes investors even more nervous and leads them to demand even higher interest rates.
As governments spend more to service their debt, they must reduce spending elsewhere. That, in turn, can choke off economic growth — and economic growth is necessary for countries to dig themselves out of debt.