European Central Bank Headquarters in Frankfurt, Germany (Image Credit: Nicholas Goodden)

The European debt crisis that has upset global financial markets for months is coming off a momentous week and is not showing any signs of calming down.  The most recent drama started on October 26th when a bleary-eyed French President Nicolas Sarkozy emerged from negotiations with other members of the eurozone announcing an agreement to help Greece move forward.  The agreement would restructure some of Greece’s debt and grant them an additional tranche of financing, all while imposing yet stricter austerity measures on an economy that is already shrinking at annualized rate of 5.5%.  The U.S. is currently growing at a rate of about 2%, by comparison.

Markets rejoiced at the news of the agreement and a seeming way forward with the Greek financial crisis.  The curveball came on Monday, November 1, when Greek Prime Minister surprised, it is no exaggeration to say, everyone in the world who has knowledge of this crisis.  He announced that he would put the agreement of October 26 to a countrywide referendum.  Even his own Finance Minister was shocked at the announcement and immediately dismissed the idea.

Sarkozy and German Chancellor Angela Merkel, “summoned” Mr. Papandreous for a private meeting on the eve of the G20 meeting in Cannes, France.  The Greek Prime Minister emerged from the meeting with no plans of going forward with the referendum.  Mr. Papandreous has suffered intense criticism for his handling of the crisis and barely won a confidence vote in the Parliament on Friday evening, but then resigned Sunday evening.  The good news for the international community for the moment is that the agreement of October 26th remains in place.  For their part, Greece seems willing, but not happy to accept deeper austerity measures in order to remain part of the single currency eurozone.

Understanding the European debt crisis is helpful to understanding our own country’s fiscal situation.  Here are four keys you need to know:

1) Greece is small.  Greek GDP(the total amount that their economy produces in a year) is about $200 billion, which means it has an economy about the size of Chicago.  Consider that fact as you consider the incredible impact it has had on the markets.

2) Next up is Italy.  They are in similar financial straits as Greece, yet their GDP is approximately $1.8 trillion.  Their impact on the eurozone specifically and the global financial markets more generally will obviously be much greater than the Greek problem.  We learned today that the markets have placed less faith in Italy’s future by charging them more to borrow money, similar to any bad credit risk.  Rumors are swirling about Prime Minister Berlusconi’s potential resignation, as well.

3) Order is good, even if it is bad.  The biggest risk that the United States and other countries face is a disorderly bankruptcy of one of these countries.  Even though the austerity measures are tough for the citizens of each country, and the October 26th agreement places a 50 cents on the dollar value on Greek debt, there is order there.  Markets like order.  If Greece were to be kicked out of the eurozone as a result of their renegging on the October 26th agreement, in the words of Greece’s leading newspaper, “social, economic, and political chaos” would ensue.  They would wake up without a currency.  Holders of Greek bonds would be left to try and pursue repayment of bonds at varying valuations by themselves.  Very disorderly – bad.

4) The perspecive we all need.  Greece has been highly criticized as a socialist country who has put many of their citizens on the government payroll, spent more they could afford on infrastructure leading up to the 2004 Summer Olympics in Athens, and generally acted as fiscal deadbeats.  A lot of that is true.  One of the key measures of a country’s financial health is their debt to GDP ratio.  To give some perspective, the average Debt to GDP ratio of the eurozone countries as of 2010 was 85.2%.  The countries that have played the part of the “parents” in the crisis, Germany and France, have Debt to GDP ratios that hover a little less than that average mark.  Greece’s own ratio is 142%.  Once again, many are worried about Italy’s fiscal health; their ratio is above 100%.  The GDP of the United States is expected to be right at $15 trillion for 2011.  The Federal debt is currently approximately $15.5 trillion, giving us a Debt to GDP ratio of 102%.  If the U.S. were in the eurozone, we should expect a visit from President Sarkozy and Chancellor Merkel to tell us to get our fiscal house in order.  And, they’d be right.