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.

15 comments so far

In other words, is this it for the Euro? The grand experiment designed to confront and upstage America in economic prowess? It is rather sad, shabby even, how this once-noble attempt is being destroyed by (petty) politics and the exigencies of finance, but there it is. Time for the historians to figure it out.

Posted by Gotthardbahn | Report as abusive

What makes everybody think that the Euro itself would be wound up if one country were to decide to leave it? If the politicians would have some balls they would use this crisis to optimize the area of the currency union, making the Euro healthier in the long run.

Posted by owe.jessen | Report as abusive

I’m not sure there is anything noble about a monetary union.

Posted by JCJ | Report as abusive

Why does the whole Euro necessarily need to collapse just because Greece is about to blow up? Ireland has already cleaned up for the most part; Italy is not even close to Greek trouble levels; Spain, despite 20% unemployment, is really hanging tough; Portugal has the biggest problems but they are jumping the gun on fixing them. I would argue that the UK is in much worse shape than any of the PIIGS (even Greece) any day… maybe an article opining the death of the UK would be more welcome than trashing Euro politics again and again.

Posted by CDNrebel | Report as abusive

Keep discussing Greece, and remember that while people were discussing Bear Stearns, things were happening at Lehman, AIG, Fannie and Freddie, Citi, BofA, WaMu, etc.

Posted by yr2009 | Report as abusive

It’s worth noting that the Argentine collapse of 2001, and default of early 2002, also saw a major refinancing and rescue package, the mega-canje of late spring 2001. It pushed back payments, but greatly increased the debt — in the end, it’s major accomplishment was enabling massive covert capital flight by international firms and the well-connected. As everyday citizens began to try to spirit their money away, the minister of the economy froze bank accounts, and everything went to hell quite swiftly. Tragically, Greece seems right on track to repeat this performance.

Posted by xaloc | Report as abusive

If Greece chooses to default on its Euro debts while remaining in the EMU then it’s obvious Greece does not understand the real nature of its predicament. A Euro-denominated refi will solve nothing – it’s just “extend and pretend” on a national, continental scale.

Posted by Sensei | Report as abusive

I think Krugman got his argument from Buiter’s paper, which is worth reading. At this point, both predictions are nothing more than stabs in the dark.

I love how we are all supposed to now be swept off our feet by the brilliance of all the great minds in the City and Wall Street who have been asleep about sovereign debt until now. Now the credit markets are getting it right, apparently, even though all that debt that has been trading at premiums was bought by the same brilliant funds. Okay they weren’t brilliant yesterday, but they are today.

You might believe it Felix but I don’t believe the City or Wall Street have any more clue today than they did yesterday. Just fast talkers making things up as they go along.

Posted by wpw | Report as abusive

Couple of comments:

1. Is it the politics that because Germany (especially Merkel and her band of Conservatives along with their friends in USA Right) was snubbing Americans for TARP so much that they are going at any length to avoid this political embarrassment? That will be tragedy because apart from Greeks, Germany and whole Europe are going to suffer here by wasting good money to Greece. So this means Germany would need more resources to shore up their banks than throwing these Euro 30Billion over the period of 3 years then…

2. Greek perspective – it is ‘never’ to sustain any kind of pain. I do not believe that society has any ‘sanity’ available so as to think ‘let us take the pain now’ so that there can more sunshine (Greece has plenty of sun shine…) days later. This also adds to the total reluctance on behalf of rest of the world to think anything constructive for Greece.

So then all these bailouts are finally to get some time only here….

Posted by umeshgeeta | Report as abusive

Nuriel Roubini has been talking about the imminent danger of sovereign default for more than a year.
No one on WS listened, as usual.

Posted by yr2009 | Report as abusive

Send a plane load of those fat banker who destroyed the world to Greece and let the Grecians make a judgement call on whether they can take back what was taken from them. One planeload should have enough capital to top off Greek debts.

Kind sad to think how so few can destroy so many…. and we tolerate this.

Posted by Butch_from_PA | Report as abusive

Oh please Butch From PA. Spare me!

Look, if you:
1. Don’t pay the taxes you are required to.
2. Let public sector workers retire in their early forties.
3. Have state owned utilities that are massively overstaffed.
4. Have a social security system that pays people simply because their father’s have passed away, even though you are over 18. (Amongst other craziness.)
5. Let unions get too much power in your society.
6. Let productivity drop to low levels.
and the list goes on…

you should expect your government to run out of money!

The Greek people have themselves to blame for this, and shouldn’t expect others to bail them out. Sure, pre Euro, they could have devalued their currency, but that will only bring short term relief to the structural issues Greece is faced with.

You live in a democracy and you have only elected politicians who have promised to ramp up benefits. You elected them to do it and they did. Now the country has run out of money, and people to borrow from. You reap what you sow! The Greek citizens are ultimately to blame for this.

You can’t go on borrowing forever.. Argentina, over the past century, is a classic example of this principle.

Posted by trewq | Report as abusive

Greece had a primary budget surplus for every year from 1992 to 2000. Once it entered the eurozone, it moved to a primary deficit, as borrowing became much cheaper. If the current austerity measures are implemented, Greece should achieve a primary surplus by 2011.

Posted by aris1972 | Report as abusive

Greece is done for, they just don’t have the right attitude. My bet Portugal and Spain are safe…..its going to be the UK thats next. Maybe the queen will sell some crown jewels and bail them out

Posted by kassie01 | Report as abusive

Gee Butch from PA and Trewq,
I was really enjoying the comments on this aricle until you guys had to start the ideology wars.

Posted by Gahooth | Report as abusive
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