The political economy of a Greek default (and euro zone exit)

In the CNBC video below, Christian Menegatti of Roubini Global Economics says Greece will have a tough road to hoe just getting back to 120% government debt to GDP. Moreover, the country will be locked out of the public debt markets for years to come, irrespective of how well they implement their austerity programs and make structural reforms.

Does the political will exist to keep Greece on EU life support all that time? What if it misses targets, will the will exist then? My answer to these questions is no. And so the logical conclusion of Menegatti’s discourse is that Greece will be forced into an untenable situation where exit from the euro zone is likely. This is what I have already written. Menegetti seems to hint at this as well.

Before you watch the video, let me make a few comments first.

For the time being, European policy makers must continue down the present path of austerity/non-default defaults because they are deathly afraid of committing policy mistakes given the weak financial sector and high private sector indebtedness. Most importantly, if things go pear-shaped, they know they will be blamed because they have no mandate to break up the euro zone (yet).

Eventually, however, the populace will grant this mandate to break up the euro zone. In the core, bailout fatigue will set in and Greece will come to be seen as expendable even if it means significant costs to prevent contagion and to recapitalise the European financial sector. In the periphery, the deflating economy that accompanies austerity will cause such social unrest that nationalist and extremist politicians will take prominence, giving a green light for a euro zone exit as well. Their mandate will be to throw off the ‘German yoke’ by any means necessary and that means default and/or exit to stop the debt deflationary spiral. Finally, it is clear by now that private sector participation will not be near unanimous. And so the likelihood of ECB participation in writedowns and a credit default swap triggering default will increase over time. To me that means default and exit – come what may.

One thing to watch out for is the terms of sovereign debt issuance as the present path moves forward. The creditor nations want to prevent the exit scenario I outlined yesterday in which Greece can convert its bonds to New Drachma under Greek law. Therefore, they will make a push to make sure any new debt is issued under more creditor-friendly terms like British law. This means that in the event of a default, Greece’s banking system would be what Marshall Auerback calls "openly insolvent". Nonetheless, I believe the politics will be so dire that Greece would try to get out anyway.

P.S. – I have a number of media appearances today focused on this issue. Expect to see a flurry of posts highlighting the different points made in those appearances. If you have the opportunity, you can still catch me live at 1630 ET on RT Television and tonight on the Lang & O’Leary Show on CBC.

Update: Here is the Lang and O’Leary video. Enjoy.

  1. Oz says

    “they are deathly afraid of committing policy mistakes”

    From where I’m sitting, the whole last two years of the Greek saga has been one huge policy mistake

  2. Ben says

    What happens to the market when Greece exits?

    1. Henri Myllyniemi says

      Greece exit is only one component. Looks like markets have already priced in this Grexit. There are many moving parts that needs to be counted: will ECB launch how much more Carry Trade LTRO, how badly the economy keeps shrinking in other troubled countries, is private debt exploding at the hands of Spaniards and how will people react to more tough internal devaluation (namely now in Portugal and Spain) in shrinking economy enviroment, because they lack their own monetary policy.

  3. Leverage says

    The only important question that remains now is: how long?

    How long until this happens? The longer the waiting the most dire the situation and higher probability of: revolts and revolution, deflation-hyperinflation collapse spiral (in which they are already are, with ugly -7% GDP last quarter, 2 years of this and their capital base will be wiped out) and even civil war.

    How far is this all credit warfare non-sense and political ineptitude and trying to hold the status quo going to continue? Reality will strike back hard if they fail to accept it fast.

    Next question is: is this the path for Italy or Spain? The consequences for world-trade and the world economy situation are telling if the answer is yes, we are approaching a new world depression and a remake of the 30’s and 40’s at best (without including demographic and resource demand problems which may aggravate the situation).

    Either we see writedowns soon in mass and further fiat stimulus to offset deflation (via cutting taxes and/or spending in vital projects to offset global imbalances, specially in the oil-derived trade, consumption and production cycle) or we will face the hard way, which is the way of poverty, inequality, social unrest and even, eventually, war.

    So tiring…

Comments are closed.

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