State of the Economy–Greece 20th June 2011


The default of Greece is not an if, but a how and when. Make no mistake, reductions in principle are a default and should not be seen as mere refinancing. The reality is that Greece will not be able meet their sovereign debt obligations in full regardless of any further ECB bailouts.

How the eventual default will impact the euro zone and global markets is a question of wording. With a default wealth is always written down and someone will be left with the bill. A bailout would enable a controlled default, which means that the ECB could slow down and partly prevent the cascading effects.

ECB austerity conditions for the next round of bailouts are toothless for the most part, because not releasing the funds and a rapidly cascading default scenario would decimate the European financial system. With the previous crisis banks were over extended with housing and artificial instruments. In this case a number of French and German banks will make sufficient losses that they no longer meet regulatory capital adequacy requirements. The European Central Bank will become insolvent, given its very high exposure to Greek government debt, and to Greek banking sector and Irish banking sector debt. The harsh reality is that nations are already over extended and would not be able to bailout the financial sector the way that liquidity was pumped in during the last crisis. Europe could start printing money the way that the US fed did, which devalue the Euro.

On the flip side, not implementing austerity measures is also not an option. A full default would lead to Greece dropping out of the Euro. The new local currency would effectively devalue over night. This would cut sovereign debt to a half (or more) over night. It would also cause massive inflation on foreign exports and Greece isn’t self sufficient by any means. If the there is a no confidence vote and nationalization of banks becomes more probable, we will see a run on the banks… people wanting to take out all their euros. This would cause the Greek financial system to implode. If the Greek government puts a hold on all withdrawals they will also need to issue martial law, which would tear a part the Greek social fabric.

One possibility is that Greece doesn’t implement austerity measures and calls ECB’s bluff. ECB pays up anyway for a controlled default. This would be the end of bailouts. This would eventually tear the euro zone to shreds and start an era of protectionism. More likely we would see a northern euro zone of financially stable nations and the those that do not meet financial targets to take part would fall into a pool of second class European nations.

In summary bailout and austerity are a must. Default will be controlled and contained. Unless confidence vote doesn’t pass and then its anyone’s guess how the meltdown will happen.

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