Timing a Greek default

By Felix Salmon
May 5, 2010
Willem Buiter has joined the group of people convinced that Greece will default. I think he's too optimistic:

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Willem Buiter has joined the group of people convinced that Greece will default. I think he’s too optimistic:

A mix of huge debt and no primary deficit – i.e. needs for external funds to pay for ongoing government spending – constitute “ the exact circumstances that makes a default individually rational for the debtor,” he notes…

The later it happens, the larger the haircut will be, says Buiter. He reckons a 30% cut today would have sufficed, but would have wrought havoc on the capital positions of Greek, French and German commercial banks, which would probably need to be recapitalized immediately, provoking major political embarrassment in Berlin and Paris.

Instead, Buiter says, the plan must be to give some time to those banks to recapitalize, or sneak Greek exposure off private balance sheets and on to public ones.

The problem here is that a 30% cut today would not have sufficed, precisely because Greece is not running anything close to a zero primary deficit. Paul Krugman makes the point:

Here’s the thing: Greece is currently running a huge primary deficit — 8.5 percent of GDP in 2009. So even a complete debt default wouldn’t save Greece from the necessity of savage fiscal austerity.

It follows, then, that a debt restructuring wouldn’t help all that much.

In fact, it’s worse still: even if Greece were running a zero primary deficit (and I’d love to know if it’s ever managed that particular feat), a default without devaluation would still keep the country mired in its current uncompetitive state. If you’re going to go through the massive pain of a default, you might as well get the upside of devaluation at the same time, and exit the euro.

At that point, the only question is: do you default and devalue now, or do you wait a couple of years? Germany and France might well want to wait, in the hope that their banks will be better able to cope with such a thing in a couple of years’ time. But from a Greek perspective, if the pain is coming, best to go through it now and bring forward the growth rebound, rather than push off the devaluation stimulus to an indefinite point in the future.

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