It's all connected a spectator's guide to the euro crisis

The global financial system is highly interconnected. So problems in one part of the world can reverberate almost everywhere else - risking a cascade of default, contagion, contracting credit and collapsing economic activity. Exhibit A now is Europe. European Union leaders met this week to at last deal with a debt crisis rattling investors worldwide who once thought lending to euro zone countries was virtually risk-free. The graphic here helps you see the intertwined complexities.

[IMG]http://i.imgur.com/eg6KT.jpg[/IMG]

It starts with the euro

In 1999, most countries in the European Union adopted the euro as a common currency. This union allowed poorer countries such as Portugal, Italy, Ireland, Spain and Greece to borrow money at the same low interest rates as rich and financially prudent Germany, even though their inflation rates were higher. That gave them a strong incentive to borrow.

And goes bad in Greece

Greece financed a large public-welfare state and built up huge debt for its size that it has scant hope of repaying now. In 2010, European financial institutions began bailing out Greece (later Ireland and Portugal, too); lenders were prodded to agree to modest, voluntary debt write-downs, or "haircuts". But Greece still needs money. And its credit bill grows ever larger as lenders charge more and demand government cutbacks, which in turn have provoked civil unrest. After years of propping up the spendthrift Greeks, the Germans are fed up. The problem is, a chaotic Greek default could hurt all European banks and pension funds that have extended Greece credit down the years, and maybe cause a wider bank panic. So bailouts continue - for now, at least:

BEST CASE Bailouts in the form of new European credit eventually work. Greece pays down its hefty debts for years to come.

MORE LIKELY Bailouts don't work. Greek debt grows in an anaemic or shrinking economy. The country defaults, either in a negotiated, orderly manner or chaotically, forcing lenders to take big losses either way. But damage could be contained if countries in the euro zone can erect a financial firewall to backstop the credit of the four other shaky nations: Ireland, Portugal, Spain and Italy. This is what the European Union agreed to on Thursday, after France prodded a more reluctant Germany.

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It's all connected a spectator's guide to the euro crisis

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