What happens when Greece defaults?

George Irvin examines the effects of a Greece default, and finds they aren’t positive for Greece or the rest of the eurozone.

Most economists agree that by late 2011 or early 2012 Greece will default. The reason is simple. In the light of soaring market interest rates (over 26 per cent this month), Greece is now entirely dependent on bailout funds to pay off its debt.

For the debt-GDP ratio to shrink, the economy must grow at a rate faster that the rate Greece pays to borrow. But the 2008 credit crunch followed by the EU/IMF imposed austerity has led to Greek recession: the economy (GDP) shrank by 4.5 per cent in 2010 in real terms and is forecast to do so by over five per cent in 2011.

By the end of 2011, Citigroup forecasts its debt-GDP ratio to be 167 per cent (pdf).

Even were the latest ‘haircut’ deal with Athens to go through, the debt-ratio would still be 120 per cent. In the absence of debt forgiveness, Greece is being pushed to the precipice.

What happens if Greece defaults depends on whether the default is ‘orderly’ (ie, debt restructuring within the euro) or ‘disorderly’; ie, Greece reneges on all its sovereign debt and leaves (or is expelled from) the eurozone and possibly the EU.

Because there is little evidence that the troika – the European Commission, ECB and IMF — are willing to agree to a major debt restructuring and/or forgiveness package, let’s assume that Greece unilaterally defaults and leaves the euro. Indeed, the Germans have hinted that this might be no bad thing.

If Greece adopted a new currency (the new drachma or ND) initially at parity with the euro, the currency could be expected to devalue very quickly by perhaps 40-50 per cent. In consequence, the Greek banking system would fail. The main assets of Greek banks – loans to Greek and other individuals and institutions – are denominated in euros.

Hints that Greece might leave the euro and adopt an ND have already led to a flight of capital — an official announcement (or even the anticipation of one) would lead to a full-scale run on the banking system. With deposits falling, banks would stop lending to one another and the economy would grind to a halt.

But that’s not the half of it. Although much sovereign debt issued under Greek law could be redenominated in new drachma, some could not; nor could much of the private debt of Greek firms and individuals. Revenue would now be in depreciating ND and paying off euro debt would become twice as hard, so bankruptcies would multiply.

With international markets unwilling to lend to Greece because of economic instability, the Greek government deficit, currently running above 10 per cent of GDP, could not be financed. So public services would be shut down and austerity would be even worse than at present, or else the deficit would need to be covered by printing money. Monetisation on such a scale would almost certainly fuel domestic inflation.

Nor would leaving the euro guarantee an export boom. Greece imports many necessities (including oil) for which there are no domestic substitutes, and since devaluation makes imports more expensive, this would generate further inflationary pressure.

As Greek new drachma prices rose, the country would lose part (or even most) of the boost to exports caused by the initial nominal devaluation. In brief, although the nominal devaluation might be large, inflation might result in a real effective devaluation of next-to-nothing.

Finally, the departure of Greece from the Eurozone might have very grave consequences in terms the accelerated spread of contagion.

Since the October 27 accord on the Greek bailout, we have seen the financial markets turn viciously on Italy. Most recently, a German bond auction has failed for the first time, suggesting markets are now factoring in a possible collapse of the Eurozone. Such a collapse would almost certainly plunge the world economy into a depression graver than that of the 1930s.

This is no time for calls to Greece to leave the euro – whether from the political right or left.

The costs for Greece could well far outweigh the benefits, as indeed the costs for Europe as a whole. Finance capital continues to shift the costs of the wider crisis to ordinary citizens. What is true is that Greece’s departure would reflect the near-criminal short-sightedness of Europe’s ruling elites in dealing with these costs.

See also:

Greece is the word: Crisis in Athens as Papandreou set to resign – Alex Hern, November 3rd 2011

Time to move beyond the eurozone – Barry Gardiner MP, September 21st 2011

Labour should break from the consensus and call for Greece to default – Barry Gardiner MP, July 4th 2011

Greece: The game is nearly up – George Irvin, July 1st 2011

Is it really best if Greece goes bust? – Ben Fox, June 22nd 2011

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29 Responses to “What happens when Greece defaults?”

  1. Political Planet

    What happens when Greece defaults?: George Irvin examines the effects of a Greece default, and finds they aren’t… http://t.co/ooySYAtG

  2. Chris Read

    What happens when Greece defaults? http://t.co/e19jGOpO by George Irvin – @gwi40 #eurozone #eurocrisis

  3. Ariana Yakas

    What happens when Greece defaults? http://t.co/e19jGOpO by George Irvin – @gwi40 #eurozone #eurocrisis

  4. Jamie

    What happens when Greece defaults? http://t.co/FU9mq3Q0

  5. David Taylor

    What happens when Greece defaults? http://t.co/e19jGOpO by George Irvin – @gwi40 #eurozone #eurocrisis

  6. javier de juan

    RT @leftfootfwd: What happens when Greece defaults? http://t.co/dv8Jntou

  7. Greece Travel Tips

    What happens when Greece defaults? – Left Foot Forward http://t.co/9OC7UT8K

  8. Mark Stevo

    The penny finally drops…

  9. Blarg1987

    Wonder will they have a tougher line on tax evasion, I am sure that would although be unpopular for some, will help them sort out their finances 🙂

  10. anestis

    What happens when Greece defaults? http://t.co/rJiseCxs

  11. pmb

    @DeborahJaneOrr dangerous times surely but Germany will flinch first rather than see the end of the Euro http://t.co/ZsHjnkSl

  12. HCE

    ''…Finance capital continues to shift the costs of the wider crisis to ordinary citizens…'' http://t.co/qCnvsG39

  13. greeceupdate

    What happens when Greece defaults? http://t.co/NFfwSDeG

  14. Nick Glantzis

    What happens when Greece defaults? http://t.co/NFfwSDeG

  15. HCE

    …την σχεδόν εγκληματική μυωπία των κυρίαρχων ελίτ… http://t.co/qCnvsG39

  16. Μαρία Νεφέλη

    …την σχεδόν εγκληματική μυωπία των κυρίαρχων ελίτ… http://t.co/qCnvsG39

  17. Stardust we are

    What happens when Greece defaults? | Left Foot Forward http://t.co/g592fyFP

  18. Cal

    What happens when Greece defaults? | Left Foot Forward http://t.co/g592fyFP

  19. Nina-Maria Potts

    'What happens when #Greece defaults?' Well worth reading http://t.co/CR0yjtjU from @leftfootfwd

  20. 001002003nz

    “@NinaMariaPotts: 'What happens when #Greece defaults?' worth reading http://t.co/4yu0R5l1 from @leftfootfwd” @mnicoletos @iantoniadis75

  21. Michael Nicoletos

    “@NinaMariaPotts: 'What happens when #Greece defaults?' worth reading http://t.co/4yu0R5l1 from @leftfootfwd” @mnicoletos @iantoniadis75

  22. Jim Christodoulou

    'What happens when #Greece defaults?' Well worth reading http://t.co/CR0yjtjU from @leftfootfwd

  23. Smile Man

    'What happens when #Greece defaults?' Well worth reading http://t.co/CR0yjtjU from @leftfootfwd

  24. Zzzxx123

    anyone should be able to see that greece was always going to default. They were just surviving on bailout money they couldnt pay back. Now the vulturs are trying to destroy a wonderful socialist country

  25. Eurozone crisis: A threat or a promise from the credit rating agencies? | Left Foot Forward

    […] also: • What happens when Greece defaults? – George Irvin, November 25th […]

  26. Goodbye Greece

    […] financial market, Greece must default, leave the euro and return to a ‘new drachma’ (ND). As I (and many others) have written elsewhere, the domestic pain will be severe. As for the rest of the Eurozone, one can only pray that Ms […]

  27. 'What Hague had to say was absolute crap': A masterclass in economic communication | Left Foot Forward

    […] What happens when Greece defaults? – George Irvin, November 25th […]

  28. nodebtnoeuro

    RT @leftfootfwd: What happens when Greece defaults? http://t.co/FG5G20aZ

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