Greek default may be likely, but not inevitable

Greek default is not inevitable or desirable. A Greek default could trigger other indebted euro nations to default.

John Kolesidis/Reuters
Greece's Prime Minister George Papandreou makes his way out of the Presidential Mansion in Athens May 27, 2011, after failing to convince opposition leaders to support tougher austerity measures. Many economists believe a Greek default is inevitable, but is it?

The consensus view among most economic analysts, both those that I normally find sensible and those that I normally don't find senseible, these days is that a debt writedown in Greece is inevitable and perhaps even desirable. I disagree on both counts.

Starting with the issue of inevitability, some argue that the high debt burden makes it inevitable . But that is not true. Countries have had bigger debt burdens historically and have in fact that right now in the case of Japan without there being any writedowns, or in the case of Japan any expectations of writedowns.

Others argue that it is inevitable because Greece has been shut out from the bond markets. But as long as other governments are willing to engage in arbitrage to provide Greece with the needed credit, bond markets are irrelevant and can remain irrelevant for an indefinite period. So long as governments don't irrationally try to end the arbitrage arrangement which will be profitable for them, no writedowns will be needed.

Of course, given the increased popularity of misinformed populists like the True Finns party in Finland that don't realize that it is a Greek default which would mean subsidies for the Greeks, not the arbitrage loans they oppose (more on this issue below) it is possible and indeed likely that this won't hold and a debt writedown will therefore come, but the point is that if these populists are shut out, as they've been in Finland so far, it is not inevitable.

As for the desirability issue there are two problems with it. The first is that a writedown would reward the Greeks for their past irresponsible deficit spending as they would be relieved of their debt. The populists who rail against having to bail out irresponsible Greeks would in fact then bring on the very outcome that they say theu oppose, and by allowing the Greeks to be relieved of their debts, this would encourage more irrespomsible deficit spending by Greece and others in the future.

One counterargument against this would be that a writedown while a writedown would reward the Greeks it would punish the banks that irresponsibly lent to Greece. But since no government will allow a bank collapse this means that it would be other governments that would take on the costs, meaning that a debt writedown would in fact be a large wealth transfer from Germany and other well managed countries to Greece, with the banks being mere intermediaries.

And if Greece can get away with being relieved of their debts, other countries like Ireland and Portugal would later want to be given the same give-aways from the rest of Europe at enormous costs for taxpayers in other countries.

Furthermore it wouldn't really solve Greece's underlying problems because for one thing some of the debts is owned by Greek banks and the losses for them would require the Greek government to bail them out, disabling Greece from escaping that part of the debt.

Furthermore, Greece still have a significant primary deficit (deficit excluding interest payments) and that wouldn't go away with a debt writedown. And just who will loan Greece the money to cover that primary deficit is unclear.

Again, because of the increased popularity of the myth that a Greek debt writedown is inevitable and/or desirable, the risk is high that it will in fact happen. But it can be avoided if people realize that it can and should be avoided as it would create more problems than it solves, especially for those of us outside Greece.

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