Opinion

Felix Salmon

Why it makes sense to fear Greek default

By Felix Salmon
May 14, 2010

Is everybody overstating the consequences of a Greek default and/or devaluation? The Economist points out that Europe has seen quite a few defaults in recent decades (Russia, Poland) and also break-ups of currency unions (Czechoslovakia, Yugoslavia) — and that none of these events caused a lot of lasting damage.

I’m not convinced, if only because the Russia default caused the collapse of LTCM and a serious crisis; if it weren’t for tough arm-twisting by the Fed and billions of private-sector dollars from America’s biggest banks, it could have been much worse. And the end of the koruna and the dinar also meant the end of the Czechoslovakia and Yugoslavia, and the worry is very much that if Greece or anybody else were to exit the euro, then the whole currency union could fall apart, endangering the EU itself.

More generally, financial markets are good at taking the collapse of risky assets in their stride: what they’re bad at is dealing with the collapse of assets they thought were safe. And until very recently, Greek bonds were considered to be an interest-rate play, not a credit play. As a result, the institutions owning them can ill afford to see big losses on them.

The euro was designed to be a super-safe currency; as such, the repercussions of it falling apart would surely be many orders of magnitude greater than anything we saw in the wake of the collapse of the unlamented Yugoslav dinar.

Mike Kinsley also notes, in the North American context, that if you don’t have an economic union, then other issues tend to get worse — like illegal immigration.

All of which is to say that the great euro experiment seems to be unwinding, the Estonia news notwithstanding, and no one knows where it’s headed over the medium term. If economics and politics become fractious and nationalized across Europe, then within the region only Germany will any longer provide the kind of safety that investors are currently looking for; everybody else is going to start returning to their pre-convergence trade levels, which were a long way away from where we are now.

So anything which threatens the unity of the eurozone or the EU is surely going to have market consequences much worse than a single day drop of a few percentage points on European stock exchanges. And right now it’s far from clear that the political will to keep the union together is going to be sufficient.

Comments
19 comments so far | RSS Comments RSS

Did everyone take leave of their senses when Greece joined the Euro? It’s the only explanation for why Greek bond yields converged with the low yielding German bonds. A decade or so of cheap debt binge and it still took a global financial crisis to expose the house of cards they’ve been building down there.

And everyone makes such a fuss about the austerity, but they have such abundant low hanging fruit. Getting more of the economy out of the black market and actually getting the middle and upper classes to actually pay some tax would be a great start. Might be a few rioting doctor’s wives but… [shrug]

Posted by MartinBarry | Report as abusive
 

Felix,

Congrats!

http://www.stat.columbia.edu/~cook/movab letype/archives/2010/05/felix_salmon_wi. html

“Felix Salmon wins the American Statistical Association’s Excellence in Statistical Reporting Award
By Andrew Gelman on May 14, 2010 12:18 PM”

Posted by DonthelibertDem | Report as abusive
 

Felix,

Congrats!

“Felix Salmon wins the American Statistical Association’s Excellence in Statistical Reporting Award
By Andrew Gelman on May 14, 2010 12:18 PM”

Posted by DonthelibertDem | Report as abusive
 

That Czechoslovakia and Yugoslavia fragmented because of reasons unrelated to economic crisis seems especially salient here. The relative values the market would have placed on the new currencies, had they existed earlier, would have been relatively stable; nobody, in short, knew they were going to get the short end of it by getting the new currency. If obligations, such as bank deposits, denominated in euros were to be converted to something that were believed to be of equivalent value, then there wouldn’t be concerns with bank runs or the like. That everybody knows that Greece would leave the euro only in order to devalue against it changes things immensely.

Posted by dWj | Report as abusive
 

“It seems that the people, their democratically elected representatives, and institutions operating in that context, sometimes need to ‘see’ the crisis approaching in order to realise the dangers and take the decisions necessary to tackle them. This is particularly the case in societies which are based on economic stability, such as Germany, and which are not used to managing crises, especially those of a financial kind. In the global world in which financial markets move rapidly, there is a risk that the reaction times are too slow and that people may sense a crisis looming when in fact it has already hit. To prevent such a risk we need great leadership by those who govern, and we need institutions to convince people to look beyond the short term and take account of the impending crisis. Alternatively, automatic defence mechanisms are needed which permit a rapid addressing of problems before a crisis breaks out.”

An interesting post by Smaghi:

http://www.ecb.europa.eu/press/key/date/ 2010/html/sp100513.en.html

“Lessons of the crisis: Ethics, Markets, Democracy”

Posted by DonthelibertDem | Report as abusive
 

Abundant low-hanging fruit is 100% correct.

Check out the latest Inside Europe report on Greece and Italy and how much house-cleaning there really is
http://dw-world-od.streamfarm.net/Events  /podcasts/en/949_podcast_inside-europe/ 01187D21-podcast-949-5458925.mp3

The report also discusses “The Baltic state of Latvia, which has the highest unemployment in the European Union, is gradually starting to recover from its economic crisis.” Seems like there is such a thing as getting by on 20% unemployment.

One more thing about Greece: John Lipsky was on Bloomberg a couple of days ago and brought up the fact that the Greeks have never opened up their economy, so there is more room yet…

Posted by Teresa_Lo | Report as abusive
 

yeah Felix….I have loved your articles. I hope the Greek people settle down and work hard to get their economy back on track

http://storyburn.com

Posted by STORYBURNcom2 | Report as abusive
 

I’m always amazed that LTCM was such a crisis barely more than a decade ago. It only had $4.7 billion in assets! Shouldn’t the fact that a fund of that size threatened world financial catastrophe been a huge canary in the coal mine for the dangers of size, leverage, and interconnectedness?

Posted by MitchW | Report as abusive
 

After hypothesizing Greek default, variously predicting Greek default and giving how-to lessons on – if not celebrating, then coyly relishing – Greek default, it’s time to Fear Greek Default? Felix, if you get any less Euro-centric, you’ll have David Cameron kicking in your door with a cabinet position you can’t refuse.

Posted by HBC | Report as abusive
 

The European Bazooka which led to a massive short covering rally on Monday has been proven a complete waste in just 5 days. Reports of political and social fissures within the European Union and more importantly the prospect of slow growth in the whole region due to fiscal cuts has led to the Euro falling even below the level of last week.This despite the raison de etre of the bailout being the “defence of the Euro” .Read more at http://greenworldinvestor.com

Posted by AGreenInvestor | Report as abusive
 

The Greek default risk to the entire Eurozone is a red herring to get German taxpayers to open their wallets. The Eurozone was put together by people and it can be changed by people.

In a few more months Greece’s face will be turning purple from the noose the IMF and the Eurozone have draped around its neck, and it will be entirely possible to get unanimous consent for Greece to exit the Eurozone and remain in the EU. Simply stating that getting unanimous consent is impossible doesn’t make it so.

All that is needed is political leadership from Germany and France, which to date has been entirely absent. But the voters of Nordrhein Westfalen now have asked for political leadership, and it’s possible the rest of the German electorate will ask for it too.

Posted by johnhhaskell | Report as abusive
 

Felix – “And until very recently, Greek bonds were considered to be an interest-rate play, not a credit play.”

Assuming duration is the same, what is the interest rate difference other THAN credit risk?

Posted by SteveHamlin | Report as abusive
 

I thought with 1 Trillion Dollar all encompassing comprehensive bailout; Greek default is in rear window. Are we not past that threshold then? The only default will be whatever IMF forces as like ‘private participation’ in re-adjusting these loans.

Three separate points – naturally the thing to watch going forward is to what an extent Euro countries are ready to clean their houses. As ECB’s Trichet and other officials clearly indicated the realization that Euro only ‘bought time’ and the permanent solution still hinges on cleaning the house; is slowly becoming public. So the question is whether European Politicians and Public walk the talk or not. Else ‘dooms day’ scenario for Europeans.

Next, Market is trying to have it both ways – first they wanted Europe to adopt austerity measures and till that wast not happening Market hammered European bonds. Now, that European countries are adopting austerity measures, stocks are getting hammered because Economy is going to miss the ‘demand’. Strictly speaking Market is not wrong – earlier it was bond and now it is stocks. But the question is European Leaders probably need to come honest & clean here to argue that ‘it is the performance against benchmarks’ which matters and Market needs to take that into account.

Finally, the reported rift between France and Germany. Reports are that France essentially formed a front with Spain and Italy against Germany to force Merkel get on the board. That kind of politics will have detrimental impacts in the end – whether rest of the Europeans are able to cow down Germany or at some point Germany simple walks out calling it enough.

Posted by umeshgeeta | Report as abusive
 

Forget about Greece -
This crisis is not about that small country on the fringe of the EU, it’s much deeper and broader than that, and it’s composed of several major political, cultural and economic unsolved problems.
The European welfare state system couldn’t be sustained, and it failed. Europe hasn’t been able to generate sufficient growth and enough jobs, and it can’t keep subsidizing large parts of its population, whether they are are social groups or entire countries.
Europe is broke, practically, and its political and economic system must change quickly in order to enable it to compete in the 21 st Century.
This is true for Greece as it’s true for Spain, France and the UK.

Posted by yr2009 | Report as abusive
 

Labels like “welfare state” don’t actually explain the problem. They are like political or religious slams. There are many so-called welfare states in northern Europe doing quite well. I don’t believe that social programs are the problem. I believe the problem is that governments pay for too many of their programs with debt. Those can be welfare programs, social security programs, bank bailout programs, and programs of continuous military campaigns around the world.

Posted by snowdude | Report as abusive
 

@snowdude
We don’t disagree, basically.
The richer, north European countries could afford to keep their welfare state system going while staying economically healthy, and debt free, but this is no longer possible, since those countries will have to bail out the entire continent through more debt, higher taxes, slower growth and inflation (I.E. stagflation).

It felt good while it lasted, but it will have to end if the Europeans want to maintain the union, which they should, since the alternative of breaking it would be even worse, unfortunately.

Posted by yr2009 | Report as abusive
 

A simple solution would be to negotiate Greece’s exit from the EU, a divorce you might say. Sometimes partnerships do not work, and you need a mechanism for an orderly parting of the ways, something that minimizes the damage.

Ask yourselves the simple question, would Greece be better off outside the EU, and would the EU be better off with Greece outside? It’s pretty obvious the answer is yes.

It is also obvious that the EU has over-reached in its expansion, and needs to shrink back to a more manageable union. Greece leaving the EU would not break up the whole union. And it could set a precedent for the orderly withdrawal of a country where things are not working out.

Posted by randymiller | Report as abusive
 

You can have a welfare state so long as your citizens are willing to pay for it. The problem comes when you have a welfare state and widespread tax evasion. I hope that pointing out that Greece has a tax compliance issue is not a “religious slam,” if their own Prime Minister has said it himself.

Posted by johnhhaskell | Report as abusive
 

No jhaskell, the phrase you’re looking for isn’t “welfare state” – it’s Social Contract. As long as you don’t violate it and mess with their basic expectations by gambling away their hard-earned cash, you can get as rich as you like and the plebs won’t drag you out of your gated community, torture and shoot you.

Posted by HBC | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/
  •