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.