The catastrophic implications of a Greek default

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UPDATE:Greek default: Optimal and suboptimal choices – Full analysis
The catastrophic implications of a Greek default
are such that force European leaders to devise
any sort of action that will prevent them.

_This is a comment I submitted yesterday in the website [<div style="text-align: center;"> UPDATE:Greek default: Optimal and suboptimal choices – Full analysis </div>

The catastrophic implications of a Greek default
are such that force European leaders to devise
any sort of action that will prevent them.

This is a comment I submitted yesterday in the website](http://www.debatingeurope.eu/) after being asked to offer my views regarding the question “Should Greece be allowed to default?”. I am sure you will find it useful so I reproduce it here.

I tend to agree with Mr. O’Neill on this issue. The risk of a Greek default affecting the eurozone and consequently the global economy is imminent, given the exposure major European banks have in the country and the share of the global economy the eurozone commands.

However even if the bank’s exposure to Greece was minimized and their position consolidated, there still are a couple of reasons that will keep the threat of a broader collapse alive.

The first is that market pressures will move on to the next most likely “candidate” to follow the path of Greece. More specifically the markets will turn their attention to the other two countries that have so far received bailouts, Ireland and Portugal, and there will most probably be speculation regarding the future of Spain, Italy (and even other countries of the European core – not to mention Cyprus that is already one step away from the need of a bailout).

The second issue is that if Greece eventually defaults, it will most probably re-adopt its national currency, the drachma (unless European leaders come up with another rabbit from their hat -which I do not think is feasible), which implies that inflation will sharply rise within a few days (if not hours), leading to hyperinflation. This means that Greece will have absolutely no capacity to trade with its European partners under free market conditions, since she will have to impose protectionist measures in an attempt to safeguard whatever is left of her economy.

The protectionist measures, together with the massive depreciation of the Greek currency, will have two effects: (a) Greek exports will become very cheap and therefore will be preferred over the equivalent products of Greece’s competitors, who are also part of the Euro (therefore the competing countries will suddenly lose competitiveness and will have pressures to make their product cheaper – which is not easy to do), (b) Greece will act like a black hole that will absorb all the money that is thrown her way without giving anything away (since she will mostly export and not import). This will understandably destabilize trade, which again will have negative implications for the rest as it will as well lead to a vicious cycle.

At any rate the catastrophic implications of  a Greek default are such that force European leaders to devise any sort of action that will prevent them. I am afraid though that European leaders have massively failed to address the crisis, not only in Greece but also at a European level and their efforts, no matter how sincere may be, will not prevent the worst from happening.

The safest way for Greece and any other country to avoid defaulting on its debt obligations, is stable growth, yet this is something that has long disappeared from Greece, which is experiencing a serious recession and things are not expected to improve. Greece (and the rest of Europe in fact) is in dire need of a growth spree that will push the wagon out of the mud, in which is now stuck. The country will also need a considerable reduction of its debt burdens as the reduction that will derive from the voluntary involvement of the private sector in the second bailout, will only reduce the debt by a small margin.

Unfortunately the packages that aim to prevent a Greek default focus on consolidating public finances and give second or even third priority to growth and debt reduction, which frankly speaking is a self-defeating policy. Reforms in the Greek economy must certainly take place, but if other things are not met, these will not be enough to lead the country out of the crisis.

Mr. O’Neill speaks of a much-needed leadership which is certainly a prerequisite to stem the crisis. I personally believe in something much more than that: a much-needed new strategy that will address the crisis as it really is – as a systemic crisis of the euro that requires audacious system-wide solutions.

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