Sure, it could happen. Greece could snub its lenders, run out of money, fail to secure additional funding and default on its debts. But the consequences wouldn’t be as horrific as many investors fear and jittery markets seem to anticipate. A Greek default, in fact, might be the very thing that speeds resolution of the whole Greek drama.
Greece’s left-wing government, led by prime minister Alexis Tsipras and his Syriza party, has a rapidly shrinking window of time to make good on the promise that led to its January rise to power: Greece will be better off if it rebuffs the tough austerity measures demanded as a condition of two bailouts by European authorities. Greece needs more money from its lenders, and if there’s no deal soon, the country could run out of cash by mid-May.
Athens has already ordered local municipalities and public institutions such as pensions and state-owned firms to transfer assets to the nation's central bank, an emergency measure indicating an urgent need for cash to pay salaries and keep the government running. Without further aid, Greece will almost certainly be unable to make a $1.8 billion payment due to the International Monetary Fund in June. And if that money somehow materializes, Greece will still face a daunting $13 billion in other debts it must repay later in 2015.
If you feel like you’ve heard this all before, well, you have. The Greek debt drama has already had a 5-year run, with many moments of crescendo and denoument. What’s different now is that the rest of Europe is far better prepared for a full-blown Greek financial crisis, while Greece itself has little or no leverage left. “This will be a relatively short-lived jitter,” says Jacob Funk Kirkegaard of the Peterson Institute for International Economics. “Some in the financial markets think people are going to sell everything and put all their money in negative-yielding bonds. If you ask me, they’re idiots.”
Default vs. eurozone exit
A Greek default would deepen the misery ordinary Greeks are enduring. But default wouldn’t necessarily force Greece to leave the euro zone and go back to its old currency, the drachma. Many press reports, in fact, treat default and a eurozone exit as synonymous. They’re not.
The script would probably go something like this: First, Greece would have to decide whom not to pay: vendors who supply the government, workers and pensioners who get checks from Athens, or creditors that loaned Greece money and are due a routine debt payment. Keeping faith with creditors is vital, but Tsipras ran a populist campaign premised on freeing ordinary Greeks from the tyranny of faraway bankers. Choosing creditors over pensioners at crunch time would violate Tsipras’s campaign promises and cut into his already shaky support. So creditors may get the shaft first.
If Greece fails to make a debt payment, it will enter default and trigger a predictable series of events. Bank depositors would try to withdraw money en masse, forcing the government to declare bank holidays and put limits on withdrawals. Since no economy can function amid bank runs and capital flight, the Greek economy would plunge into recession and possibly depression. Output could easily drop by 10% or more. Hyperinflation might ensue.
In the aftermath of default, Greece would be shut off from any further funding from the IMF, the European Central Bank or other such authorities. That’s why Greece, in theory, would have to exit the eurozone: It would have to start printing its own currency. But something else is much more likely to happen: The Syriza-led government would collapse, forcing the election of a new coalition. And a new government would probably be more willing to accept bailout conditions, returning Greece to the status quo and solidifying its place in the eurozone.
Greek citizens still favor eurozone membership by large margins. “The possibility of new parliamentary elections would likely return a YES verdict on [eurozone] membership based on recent polls about Greek citizens’ attachment to the euro,” analysts at Citi wrote recently. If a new government signed on to old bailout terms, Greece would pay what it owes, new loans would become available, Greece would begin putting the pieces back together and default would end.
Whatever the chaos in Greece, the rest of Europe has spent 5 years building shock absorbers to protect against the worst-case scenario. The ECB has now started Federal Reserve-style quantitative easing, allowing it to combat a crisis by pumping money into the system. Many banks and investors once dangerously exposed to Greek debt have pared their holdings and taken other protective measures. The value of the euro, meanwhile, has been plunging, giving European exporters advantages they didn’t have until recently.
No contagion likely
Equity traders remain skittish about how markets might react to a Greek default, but bond markets tell a different story. In 2011 and 2012, when investors worried Greek financial woes could spread elsewhere, interest rates on 10-year Italian and Spanish bonds crested the unsustainable level of 7%. Rates on such bonds are now below 1.5%. Portugal, often considered the next most vulnerable eurozone nation after Greece, couldn’t even borrow back then; today, its 10-year bonds fetch just 2% or so, a sign there’s little worry of Portugal following Greece into oblivion. Rates on Greek 10-year bonds are around 13%, but even that is far below the peak of 40% in 2012.
Greece, of course, wants to make the risk of a cascading financial crisis seem dire, since that would give its creditors more incentive to grant concessions. Greek finance minister Yanis Varoufakis and others routinely claim that creditors refusing to meet Greece’s demands are “playing with fire” and risking the stability of all Europe. Other European leaders claim the same thing as a way of pressuring Greece to cave, lest it to be one responsible for the unraveling of Europe.
But the plain truth is that Greece could end up the sole loser if it defaults. “If the Greek government escalates by not paying, they’re the ones who are going to get hurt,” says Kirkegaard. “The kind of contagion we saw in 2010 and 2011 is not going to be there.” The drama could still last for years, as Greece wrangles money and tries to slip out of loan terms. But the plot has become numbingly familiar: Greece always returns to the bargaining table.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.