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IMF Special Report: Greek Default? Bring It On

Compassion fatigue in Germany and elsewhere is on the rise. It appears increasingly likely that Greece might accommodate calls for its default, leave the euro and possibly spark an implosion of European institutions.



A growing chorus of economists appears ready to call the bluff of bankers and bondholders, who have warned that the world will more or less come to and end if Greece defaults on its debt. To those who predict that a default would lead to a global recession or a repeat of the credit market shutdown of 2008 and 2009, the skeptics are essentially arguing “bring it on.” 

For weeks, German financial authorities have said that a refusal to consider the possibility of Greek default leaves Germany vulnerable to endless demand for bailouts. Now, there’s a growing consensus that more bailouts will throw good money after bad and will succeed only in delaying an inevitable crisis. And as strikes and protests continue throughout Greece, compassion fatigue in Germany and elsewhere is on the rise.

  • Economist Nouriel Roubini aruged in the Financial Times on Monday that “Greece Should Default and Abandon the Euro.”
  • In Germany, one news organization proclaimed on Monday that a Greek exit from the euro and a return to the drachma would create more opportunities than risk.
  • George Soros argued in the New York Review of Books that successfully resolving the debt crisis in Europe might require thinking the unthinkable when it comes to default. “To start with, it is imperative to prepare for the possibility of default and defection from the eurozone in the case of Greece, Portugal, and perhaps Ireland,” Soros wrote.

Given the turn of events during the last 48 hours, it appears increasingly likely that Greece might accommodate calls for its default, leave the euro and possibly spark an implosion of European institutions. On Saturday, the Greek prime minister, George Papandeou, cancelled a trip to the United States, where he had been scheduled to meet with the Treasury secretary Tim Geithner and the IMF chief Christine Lagarde.

Greek finance minister Evangelos Venizelos is scheduled to speak by phone on Monday evening with IMF and EU officials about the fate of the sixth installment of Greece’s first bailout package. A second bailout was approved in July, but Greece may not qualify for those funds either, unless it proceeds with budget cuts that have sparked fierce--and sometimes violent--opposition.

The prospects of a Greek default rippled through financial markets on Monday. The yield on Greece’s two year debt soared to 60 percent and the yield on its 10 year debt rose to 22 percent, an inversion of the normal yield curve. Stock prices around the world fell, led by a 2.72 percent decline in the bluechip Stoxx 50 index. In Hong Kong, stocks lost nearly 3 percent. In the United States, S&P 500 futures were 1.4 percent lower, the price of oil and Treasury yields fell and the price of gold rose as investors sought safe havens.

Roubini reasoned that fiscal and monetary policy will fail to save Greece, which is in need of a currency devaluation. That devaluation can’t occur as long as Greece is part of the eurozone.

There are other paths to devaluation, besides default. But they would take between five and 10 years, and Greece can’t afford to spend that much more time mired in depression, he said.

The economy of Greece is expected to contract about 5.5 percent this year, and unemployment already is above 16 percent. Deflating prices and wages will only make the depression worse.

Even if “internal devaluation” eventually succeeded in bringing fiscal order back to Greece, the project would take five years and kill the economy. Another option, weakening the euro, is unrealistic because Germany is too competitive relative to the United States to support that sort of currency realignment.

The only option, therefore, is for Greece to default, leave the euro, and do its best to manage the ensuing mess, Roubini says. “Of course, this process will be traumatic. The most significant problem would be capital losses for core eurozone financial institutions,” he says.

But he says those problems can be “overcome,” just as Argentina addressed the fallout of its move in 2001 to pay back its dollar debt in pesos. Greek banks can be recapitalized with money money saved by the default. And Roubini says those who fear that a Greek default will lead other countries in Europe to renege on their obligations are in denial. Portugal may need to default regardless of what happens to Greece, and Italy and Spain will need liquidity support from Europe regardless of how the crisis in Greece is resolved, he says.

Markets are moving past the point of freaking out about a Greek default. That just makes the odds of default even higher.

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