Economist Offers Antidote To Debt Contagion

The Greek debt crisis had protesters marching, bankers scrambling and markets roiling this week. Even if Greece succeeds in tightening its belt, economists are worried about the spreading of financial panic to countries like Spain, Portugal and Ireland. Host Guy Raz talks with economist Jeffrey Sachs about contagion — and its financial-world antidote, "shock treatment."

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GUY RAZ, host:

This is ALL THINGS CONSIDERED from NPR News. I'm Guy Raz.

(Soundbite of rally)

RAZ: If you were wondering why the financial crisis and the recent rioting in Greece matters to you, well, the answer came on Thursday.

Unidentified Man #1: There was a lot horror because, you know, this was, to me, we were seeing right off the cliff. One minute it's down 400, the next minute it's down 500.

RAZ: The markets wiped out more than six months of gains in a matter of hours. And the debt crisis in Greece may have been a partial cause. That's still being investigated by Wall Street regulators. But one thing is certain: there is a lot of uncertainty now both on Wall Street and in Europe of where things are headed.

And when economists start using medical terms, it's a pretty good sign that things are not going well. In recent days, you may have heard many of them using a specific term.

Unidentified Woman #1: How do you assess the risk of contagion?

Unidentified Man #2: And now we got the risk of contagion.

Unidentified Woman #2: Do you think that the risk of contagion...

RAZ: There's no single, agreed upon definition for contagion. It's basically a financial crisis that starts in one country and spread rapidly, like a virus, to several others. And the worry now is that what's happening is Greece is about to reach Spain like a fast-moving storm.

Economist Jeffrey Sachs, who teaches at Columbia University, is widely credited with developing a way to stop the bleeding. It's informally called shock therapy. And he's with me to explain how this all fits in with what's happening in Europe.

Jeffrey Sachs, welcome.

Professor JEFFREY SACHS (Director, Earth Institute, Columbia University): Nice to be with you.

RAZ: Right now, there's a fear that what's happening in Greece can move to Spain. It's being called contagion. Can you explain what your definition of contagion is?

Prof. SACHS: Contagion means when a virus spreads, or in the case of finance, when a panic spreads. When the people and institutions who would be buying the bonds of governments are trying to cover their bills by selling this paper suddenly find that they can't sell them anymore because everybody fears that everybody else is going to stop buying.

RAZ: I'm curious about this idea that economists not only disagree on what contagion means, but they don't really know why it happens. I mean, how much of it is simply about smoke-and-mirrors, about perception?

Prof. SACHS: That's the issue that, to an important extent, panic is a self-fulfilling prophecy. It's like asking a question why was there a stampede out of the stadium after the football game. Something that happens on rare occasions, but then it's devastating. And the answer is there was a fight in the stands and people started to move away. Someone tripped. Someone tripped over them. People started to run. Others saw that they were running, then there was a mass movement towards the exits.

In other words, a small change to the system can trigger momentous, often very tragic, effects. And that happens in financial markets as well.

RAZ: So right now, investors are pulling money out of Greece and the fear is that they may start to do the same in Spain and then in other countries with large debt burdens like Italy and Portugal and Ireland. I mean, is that a possible scenario?

Prof. SACHS: Everything is possible. I think that it is not likely, in part, because Europe, which has a shared responsibility for their common currency, the euro, has finally woken up. And so just in the recent days, the European leaders, Chancellor Merkel, President Sarkozy of France have said: We need a much more effective and direct mechanism.

But the fact of the matter is that letting the Greek crisis just continue to boil the way that it has in recent weeks is a tremendously undermined confidence in the euro. And it has opened the way for this risk of contagion actually occurring.

RAZ: And say it does happen, how would you stop it? I mean, would you use what was described as shock therapy? And, you know, what is that? And how would you implement that?

Prof. SACHS: Well, shock therapy is a term that could cover all sorts of circumstances often as referred in the past to ending hyperinflations. Here, what one needs more is a kind of shock of confidence to the markets that country acts, whether it's Greece, or Portugal, or Spain, is simply not going to default on its bonds.

And the way to do that is to say that the European Central Bank is not going to allow that to happen. That the other countries of the euro area will not allow that to happen, because they will lend the money needed to rollover the debts, or that the International Monetary Fund will make loans to enable this to occur, or our Fed would make swap agreements with the European Central Bank so that any run on dollar deposits in Europe could be met by loans from the European Central Bank.

RAZ: Jeffrey Sachs, we keep hearing about how our economy is on a more solid footing, you know, sort of heading out of recession and so on. But I wonder whether a massive financial crisis in Europe could send the U.S. economy back into recession.

Prof. SACHS: What's happening in Europe is not good for us. And we also should take note, Europe is facing a crisis of confidence in the management of the budget in Greece, but also in some of the other countries. The UK also has a big budget deficit.

We have a huge budget deficit in our country as well, about 10 percent of our gross national product. We also have bitter political divisions in this country of whether to cut spending or raise taxes or make some combination of the two. If we can't find a gradual flight path, which takes that budget deficit down in a way which commands a broad support, it won't happen now, it perhaps won't happen in six months or a year or two years. But this will weaken us one way or another and, at some point, could create yet another crisis.

RAZ: But in the short-term, what's happening in Europe could result in more fluctuations in our markets here.

Prof. SACHS: Of course, we've seen how the stock market responds, how confidence responds. This is not good news for the U.S. or for the world. We need all parts of the world economy successfully pulling out of this downturn. And when any major engine of growth falters, the rest of the world feels the effects.

RAZ: That's Columbia University economist Jeffrey Sachs. His most recent book is "Common Wealth: Economics for a Crowded Planet."

Jeffrey Sachs, thanks so much.

Prof. SACHS: Pleasure to be with you. Thank you.

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