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.

This post originally appeared at Credit Writedowns and is posted with permission.

5 Responses to "The Political Economy of a Greek Default (and euro zone exit)"

  1. diatoo1   February 15, 2012 at 2:12 pm

    I wonder whether the next 130 + 15 billion would not be better used for participating in ring-fencing other countries after Greek default.

  2. Aegean1972   February 16, 2012 at 1:57 am

    I totally agree with the article.

    The euro-core is pushing Greece out the door and opening Pandora's Box for the chain reaction to start. A chain reaction that will gradually push other euro-nations back to their own currencies and away from the German sado-austerity politics of hard recession.

    John Paulson wrote yesterday: “The euro is structurally flawed and will likely eventually unravel”. Thats my opinion as well.

    Europeans never wanted to drop their cultural identity, to become something they didnt believe in. And now the crisis is inflating these feelings. Right wing and leftist parties are gaining serious momentum. So serious that they can even overthrow long-established political parties that have existed for decades. High uneployment and taxes bring social unrest and riots.

  3. Aegean1972   February 16, 2012 at 1:58 am

    Germany has a (maybe) a month to change the course of the boat. Otherwise Greece WILL detonate.

    Just yesterday, Papoulias, the president of Greece (who is a humble, conservative, respected and down to earth politician) in a public speech openly criticised euro-policy with a hard statement : ""I cannot accept Mr Schaeuble insulting my country … Who is Mr Schaeuble to insult Greece? Who are the Dutch? Who are the Finnish? "We were always proud to defend not only our freedom, our country, but Europe's freedom too."

    When even the humble and pro-european politicians reach their "boiling-points", you can imagine how low the unity of Europe is at the moment.

    Europe is about to blow a gasket.

    • diatoo1   February 17, 2012 at 7:42 am

      The unity of Europe is not only low now but it has always been low and every country had nothing in mind that its own interest. This difference as compared to a federal state like the US or Germany is in my opinion the main reason for that a bailing out at all costs is not going to happen. The present crisis may highlight the need for a european federal state (at least for the EU zone) but the crisis will not allow the time to do so. And unlimited bail-out now against revocable promises for building a EU federal state are also unlikely to happen. So, I guess, there are two catastrophic options only to choose from.

  4. Anthiny   February 16, 2012 at 2:35 am

    Angela Merkel has been outspoken so far that she is against a Greek EZ exit. She certainly has more influence than Schauble.