Following news coverage can be easy. Understanding some of the terms it uses, less so. In our Flashcard series, The Atlantic explains ideas you may read about but never see spelled out. In this installment, we explain the so-called "contagion effect" in Europe's financial markets.
Greece's debt crisis won't stay in Greece. It's quickly becoming Europe's nightmare. Newspapers often refer to Greece's inability to balance its own checkbook as a kind of "contagion effect" that could spread through the continent. How can a nation's debt be like a disease?
First, let's think about debt. A country's debt is the accumulation of past deficits. It equals the total sum of promises to pay back the bonds, or loans, it sells to investors in order to run the country. If the country pays back the bonds on time, hunky dory. If it cannot, the country is in "default."
If debt is a promise, default is an acknowledgment that the country was lying, and the "contagion effect" is the paranoia that there are more liars.
Here's how it works: one country gets into trouble -- usually with some combination of high deficits and weak growth -- and becomes at risk of defaulting, or breaking its promise to pay back its money. Investors smell losses, and they look around to identify more trouble, assuming that countries with similar problems will suffer similar fates. Think of it as a kind of fiscal discrimination, or financial profiling. It doesn't matter if you're at risk of default. It matters that you look like some other country that is guilty of gross financial recklessness.