Question

-Explain why the Greek Credit Crisis can result in contagion throughout Europe

- Since the Federal Reserve recently lowered the interest rates YET the dollar strengthens relative to the euro, assuming no govt. intervention, what must have happened?

Answer 1

Greece’s debt crisis began in 2010, most international banks and foreign investors have sold their Greek bonds and other holdings, so they are no longer vulnerable to what happens in Greece. (Some private investors who subsequently plowed back into Greek bonds, betting on a comeback, regret that decision.)

And in the meantime, the other crisis countries in the eurozone, like Portugal, Ireland and Spain, have taken steps to overhaul their economies and are much less vulnerable to market contagion than they were a few years ago.

To avert calamity, the so-called troika — the International Monetary Fund, the European Central Bank and the European Commission — issued the first of two international bailouts for Greece, which would eventually total more than €240 billion.

The bailouts came with conditions. Lenders imposed harsh austerity terms, requiring deep budget cuts and steep tax increases. They also required Greece to overhaul its economy by streamlining the government, ending tax evasion and making Greece an easier place to do business.

The dollar is so strong for three reasons. First, the Fed ended its expansive monetary policy as the economy improved. It stopped adding to the money supply. This constrained the supply of the dollar and increased its value.  

It meant that U.S. Treasury notes would attract higher interest rates in the short-term. That increased the demand for dollars. Savers earned a higher rate of return on dollar deposits than on euro deposits, which paid lower interest rates.

Second, the European Central Bank lowered the value of the euro by doing the opposite. Political instability in the European Union also weakened the euro. The euro to dollar conversion and its history shows how the euro has fared against the U.S. dollar through the years.

The dollar automatically strengthens when the euro weakens.This means that whatever makes the euro weaker will make the dollar stronger and vice-versa. Each of the other currencies in the USDX has less influence on the dollar’s value.

Finally, forex traders intensified the strength of the dollar. They used leverage to further weaken the euro and strengthen the dollar.