What if Greece goes bankrupt?

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UPDATE: Greek default: Optimal and suboptimal choices – Full analysis

Important Note: This article was written in May 2011. It is still relevant but I highly recommend you browse the articles covering the Greek Crisis and the Euro Crisis to be updated.

Given the severity of the Greek sovereign debt crisis, the possibility of default is quite a possible scenario. Other things equal Greece will definitely restructure its debt in the near future, which practically means that the creditors will lose much of their money. This is still the optimistic scenario though, as the pessimistic approach says that Greece will declare default in maximum one and a half years from now (or even earlier if it doesn’t receive the next payment from the troika).

Under such conditions, it is interesting to develop some of the possible scenarios that might occur regarding the impact a Greek bankruptcy will have on the euro, on the European Union and perhaps on the global economy. To formulate the possible scenarios we first need to take some real facts into account.

The first parameter that we need to take into consideration is that most of the Greek government bonds are in the hands of German and French investors (banks basically), while a small part is held by Cypriots. In simple words this means that most of the money that Greece has to pay back, will be given to Germans, French and to some extend Cypriots.

Another factor that we cannot omit is that Greece belongs to the eurozone, whereby a failure to save Greece would send all those necessary negative messages to the markets that would convince them that other euro countries such as Portugal and Ireland might easily meet the same fate.

The third fact is that Greece has received the biggest bailout ever to be given to a country (110 billion euro) and if that amount does not prove enough to prevent bankruptcy, then what can?

Given the above facts, the first scenario suggests that a Greek collapse will transmit the crisis to the countries of the creditors who have already started shaking. Hence the problem will multiply geometrically, meaning that a much deeper crisis will come with serious consequences on the integrity of the EU.

The second scenario is that the markets and the speculators (they are the same basically), will be more than convinced that other countries who currently face similar problems with Greece will also be brought on the verge of bankruptcy. Countries such as Portugal, Ireland and even Spain, who will no longer be in a position to fulfill their obligations towards their creditors, since if the markets lose any faith in their capacity to pay back, they will simply not lend them any money, which practically equals bankruptcy. In the parlance of the markets such an occasion will raise the spreads of the government bonds into exorbitant levels. So either they will have to receive more money from the European Safety Mechanism or declare default. No matter the case the two speed Europe, will become two-tier as I have already written in a previous article.

The third scenario is the combination of the above two, which is understandably the worst possible case. The European periphery will practically come to the position where Greece currently stands, while the European center will experience serious shocks, with the ramifications being unpredictable but surely worrisome. At any rate the single currency will collapse and the EU architecture will have to undergo fundamental reforms (extremely difficult) or go down as well. And of course if the EU collapses there is no telling as to what might happen at a global level. Surely something really bad. After all do not forget that the US economy is also in a really bad situation.

No matter the scenario the sure thing is that all will be more or less affected if Greece goes bankrupt. As such the Greek crisis is in fact a European crisis and I personally see no way out of it as things currently stand and with the kind of measures that the European leaders currently have in mind.