The inevitability of Greek default

A version of this post appeared yesterday at Credit Writedowns.

I am running a poll on whether Greece will default. Please click here to vote. And feel free to comment on why you voted as you did.

German Chancellor Angela Merkel is feeling pressure to force German banks to take a haircut on Greek debt by both her own party and opposition leaders (like Frank-Walter Steinmeier, the former Vice Chancellor and now head of the opposition in the Bundestag).  This is the first public indication that German politicians recognize that a Greek default would negatively impact the capital base of German domestic institutions which hold large amounts of Greek sovereign debt.

So, now the rhetoric is shifting away from one purely of austerity for Greece in return for (the now larger) aid to one in which Greece undergoes a voluntary restructuring. Yves’ most recent post on this topic tells you that. On Friday, in a post based on Marshall’s BNN interview, I mentioned three scenarios for Greece at this juncture.

  • In scenario one, you eject Greece from the Eurozone, they devalue their currency and, after a turbulent period, they are on the road to recovery.
  • Outcome number two is to depreciate the Euro, of course. The Euro is dropping as we speak.  But, I am talking about a more serious decline. As I recall, the Euro dipped to as low as 83 cents during Robert Rubin’s strong dollar policy days.  If the EU structures the bailout in the right way (fully backstops the period of increasing debt to to GDP) and floods each country with liquidity (aka prints money), you are sure to get this kind of outcome. Everyone gets a massive boost to competitiveness. Problem solved.
  • Neither of these scenarios is particularly palatable as they are likely to increase already mounting trade friction.  The other Edward mentions the only other viable alternative: a restructuring or default.

So, where there has been a lot of political posturing around scenario number one (or its analogue in Germany and a few core Europe countries leaving the euro), there has been little public discussion from policy makers about scenarios two and three. In the link in the last bullet above, Edward Hugh puts it in plain English.

At the same time, some sort of Greek default is now no longer simply a theoretical possibility among many others, indeed talk of the inevitability of some form of debt restructuring (albeit voluntary) grows with every passing day. Erik Nielsen European Economist with Goldman Sachs said this week he is expecting Greece to offer some sort of “voluntary debt-restructuring” to creditors over coming months, while JP Morgan issued a research note saying that while such restructuring may not be imminent, the move would make sense given that Greece could be seen as “the sovereign analogue of a ‘bad’ company with a bad capital structure”.

Restructuring is simply a polite word for default, with the difference that it is normally carried out by agreement. The most likely form of restructuring in the present context would be debt rescheduling, whereby short and medium-term debt is converted into a long-term version, as happened with the so-called “Brady bonds” devised by the US Treasury to resolve the debt difficulties of a number of Latin American countries in the late 1980s.

Two weeks ago, we were considering the options including True Fiscal Austerity (see Greece And The Potential Upside In An IMF Rescue). Yet, while Marc Chandler mentions raising the pension age to 67 without exception as part of a True Fiscal Austerity solution, few are talking about True Fiscal Austerity as a solution anymore. It’s now either a default or restructuring within the euro-zone or a break-up of the euro-zone (and default or currency devaluation). This is a signal that things have deteriorated significantly. The worry now must be contagion inside the euro-zone and within the banking sector.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Greg

    Absurd. If the EU allows Greece to default, then hedge funds would start targeting the EU’s other weak members. The EU has to stop the threat.

    The easiest thing to do is offer loans at around 5%, below current market rates but still high, with a condition of fiscal cuts. There should be a real threat of Greece being kicked out of the EU if the fiscal cuts are not implemented to tie Greece’s hands.

    Greece is a very small percentage of the economy of the EU. The EU nations easily can extend the necessary loans to Greece at reasonable rates. The only question for Greece should be whether it wants to stay in the EU and is willing to implement the fiscal cuts necessary to do so.

    1. Vinny

      Do you men the EU, or the Eurozone?

      One can be part of the EU and still show complete fiscal irresponsibility (e.g., many Eastern European nations). But unless they’d get their act together, they would not be allowed to join the Eurozone.


    2. Greg

      And, look at that, four days later, what I predicted is exactly what happened. Loans at 5% extended in exchange for fiscal cuts.

  2. Blue

    Why is a Greek (or any Euro member) default such a big deal? The previous solution under their own soverign currency was to devalue. What’s the difference to a creditor if they lose money via devaluation vs. default?

    The grand Euro idea is still valid: a strong currency as a store of value across the continent. Outright default is the appropriate outcome; keep the unit of measurement (currency) solid.

    1. Vinny

      I think this German fixation with a “strong currency” is showing its flaws right now. It may work for the Germans, but we can’t all be Germans now, can we.


  3. Martin

    Can someone please explain to me how devaluing whatever currency Greece uses (Euro or Drachma) is going to help with a government deficit? I simply fail to see how this is a problem of having joined the Euro at the wrong exchange rate.

    Unless the argument is that a devaluation will improve the Greek economic situation so much that a the current tax rate the budget deficit will be closed.

    1. Adam

      “Can someone please explain to me how devaluing whatever currency Greece uses (Euro or Drachma) is going to help with a government deficit?”

      While an immediate devaluation wont fix the deficit it does 2 things that should help in the near term: A) Makes export goods cheaper increasing their demand and hence taxes from employing more people in a growing export sector. B) Makes imports more expensive which should make domestic producers more competitive improving their income and taxes paid. It also might stoke inflation which will drive inflation and inflated tax revenue – debts are held in nominal terms.

      “I simply fail to see how this is a problem of having joined the Euro at the wrong exchange rate.”

      Basically Greek workers are overpaid versus other EU workers (German workers inparticular), however Greek and German goods are sold in the same currency. If they were in seperate currencies the disparities in income would be corrected in the exchange rate. Without the seperate currency Greece can only become competitive via an “internal devaluation” which involves a lot of pain. In Greeces case its so bad you’re basically asking for violent revolt – it’s never successfully been done on that scale before!

      “Unless the argument is that a devaluation will improve the Greek economic situation so much that a the current tax rate the budget deficit will be closed.”

      That is part of it. The other part is that the country can then revalue without internal devaluation, and its a partial default (they’d be paying back their bonds in a devalued currency).

      1. Fair Economist

        Isn’t Latvia’s recent austerity program of the appropriate size? That has caused a local depression, so it’s certainly unappealing, but it is possible.

      2. pebird

        “Greek workers are overpaid versus other EU workers”

        I think it’s more accurate to say that Greek labor is more expensive. One reason is that labor is taxed at a much higher rate than property. The only place Greece is able to collect taxes with consistency is from wage withholding. Wages have increased more to pay for tax burden than to increase worker incomes. So capital investment along with productivity stagnates. Also property owners are very adept at avoiding taxes: 1) there is a low rate, 2) don’t pay them anyway.

        Don’t confuse high labor cost with high worker income. That’s like saying since the US taxpayers are funding the bailout they must be living on easy street.

  4. Lyle

    Consider that its likley no government in Greece could survive an severe austerity program. The strikes would become continuous and no planes would fly, trash would be picked up, ferries run etc. There are limits to what democracies can impose on people, before they decide that the different arrangement would be more conducive to their pursuit of happiness. (Paraphrasing Jefferson).

    1. Vinny

      “The strikes would become continuous … trash would [not] be picked up”

      Since nobody’s doing much of any use here, you can call that a continuous strike… I believe it’s been going on for the past 2000 years or so.

      As far as the trash goes, I believe last time trash was picked up here, was also about 2000 years ago. There’s mountains of it lying around. Trust me on this one, because I have to stare at it every day.


      1. Alain Maronani

        Frankly I am French writing from Montreal. Your prejudices against Greek people is racism and utter ignorance of this country, people and great cultural tradition.

        Greece exists for 4000 years and gave us the greatest philosophers of all times (Platon, Aristotle), a good chunk of geometry, mathematics and the greatest conqueror of all (Alexander the Great). Travel to discover something, once in your life and try to educate yourself a bit….a challenge probably…
        I am surprised that Yves Smith allows such comments in a blog well know for quality….

  5. Martin

    Thanks, Adam (and others). This is pretty much what I thought. The only argument that, to me, suggests that the Euro is to blame, is that Greece cannot reduce its debt by devaluing, but that would require Drachma-denominated debt, plus you would trade debt restructuring for all kinds of exchange rate nasties.

    So in a sense I still fail to see why people blame this on the Euro, rather than, say, on the Greek government’s inability or unwillingness to collect enough taxes.

  6. craazyman

    Send them 100,000 Greek virgins, if they can be found, and let the Germans and the Greeks thereby increaseth themselves and prosper together. They will earn their way out of this mess, the old fashioned way.

    1. Vinny

      I’m sure you’d find 100,000 Greek virgins, but they’d be terribly ugly. Better for the image of Greece if we send them 100,000 Greek male prostitutes…lol


  7. Abhishek

    The EU-IMF plan will lead to severe unemployment,GDP decrease and some economists suspect that this will eventually require debt restructuring anyway as the Greek economy contracts due to the harsh austerity measures .This restructuring which would require “sacrifices” to be made by the Greek people and not by the financial institutions . I wonder if Germany,France and other EU members really bailed out Greece or they bailed out their own financial sectors which had a significant Greek exposure. Guess who will be the main winners/losers of this bailout script. As usual Winners – Financial Institutions , Losers – Common people . Note there is a separate package to rescue Greek banks as well but not much of a package for the Greek people for whose ostensible benefit this package is designed to be.

  8. blue monkey

    Greece and Spain won’t pay back. The only thing Germans can do is:
    REPOSSESS 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
    U.S.A must REPOSSESS 170 F-16 Jet Fighters from Greece, … the rest is gone with the wind …forever …
    Greece must stop paying lucrative pensions with borrowed money, reform the free health care system, and cut down, 4 times the military budged.

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