Debt default by Greece would undermine credibility of the euro

"Theoretical alternatives aren't pretty."

By JAY BRYAN, The GazetteApril 27, 2010 2:05 AM

At first blush, it's a little hard to understand why financial markets in Europe and North America are paying so much attention to a debt problem in a little country like Greece.

Greece has only a modest stature among the 16 countries that share the euro. Its economy is one-eighth the size of France's, for example.

But in this case, it's not really the Greek problem itself that scares investors so much. It's more the fact that the Greek government's debt crisis acts something like a canary in a coal mine.

If Greece should keel over financially, investors are very worried that this will be just the beginning, with Portugal, Ireland and even bigger countries like Spain and Italy quite possibly swooning under their own huge debt loads.

With a Greek debt default, for instance, these weaker economies would be "hammered" by skyrocketing interest rates on their government lending, predicts Mo Chaudhury, a finance specialist at McGill University's Desautels Faculty of Management.

Beyond this, any debt default by Greece would undermine the credibility of the euro, a serious problem for all of Europe. Investors would become wary of the euro zone, pushing interest rates up and stock markets down.

As well, big banks in the region, still struggling to recover from the financial crisis that hit in 2008, would be further damaged.

They hold billions of dollars worth of Greek government bonds, putting them in line for huge losses that could hamper their ability to support the area's economic recovery, since losses diminish a bank's ability to lend.

Financial specialists like Aron Gampel, an economist and vice-president at the Bank of Nova Scotia, still express a degree of confidence that Greece will pull through its present crisis, but this is largely based on the lack of any credible alternative.

"It's almost hard to believe that you could possibly cut enough to relieve such a horrendous burden" of government indebtedness, Gampel said yesterday.

Nevertheless, he added, with the world economy recovering - which will help Greece's export earnings - and its partners in the euro currency zone left with little choice but to keep Greece afloat, "I think it will be contained."

Chaudhury seems to lean toward the same conclusion, and for the same reason.

There are theoretical alternatives to the current rescue plan, which would see about $60 billion in affordable loans pumped into Greece by the euro member countries and the International Monetary Fund, but they aren't pretty.

One would be for Greece to simply default in some fashion, perhaps paying a fraction of its bonds' face value. Argentina did this in 2002.

But the likely consequence would be to get shut out of any further borrowing on foreign markets, which is what happened to Argentina for several years.

A second alternative would be for Greece to leave the euro zone, once again issuing its own national currency, which could be devalued. That would make Greece more competitive on world markets, boosting its economic growth.

But beyond the difficulty of making this transition, imagine the immediate impact of a Greek currency worth, say, half as much as the euro. It would simply make debts in euros or U.S. dollars twice as onerous for Greece to support, notes Chaudhury. So the theoretical gain could be trumped by immediate insolvency.

That leaves the bailout, which should give Greece some breathing space while it slashes government benefits and salaries to help balance a budget that has far outrun the country's means.

"There is misery ahead for the Greek people," said Chaudhury, but the cushioning effect of a bailout could at least minimize this.

And in the longer run, it's even possible that the agony of Greece will bring benefits for all of europe.

Greece isn't the only country that has let its spending spiral out of control, Chaudhury pointed out, and the mess in Greece might have been just the example that other members of the euro zone needed. Today all can see that unpopular as it is, voluntary cost-cutting is less painful than forced cost-cutting in the middle of a crisis.

"In the end," said Chaudhury, ''this could turn out to be a good thing, not only for Greece, but for the rest of europe, too."



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