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Home » Discuss » Topic Forums » Economy Donate to DU
asymptote Donating Member (2 posts) Send PM | Profile | Ignore Wed Nov-09-11 06:26 PM
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33. basic summary
If Greece defaults, all the European banks holding Greek bonds as assets will eat substantial losses on their now-worthless status. But that's not even the start of it. Greek debt is a relatively small percentage of that which is being held by European banks; the real problem is that if Greece defaults, bondholders would start to think "Oh, crap, Italy, Spain, and Portugal might default too!" and, in an archetypal self-fulfilling prophecy, would start selling off those countries' sovereign bonds en masse, which would cause interest rates on the bonds to go up, which would make them more difficult to repay, which would result in Italy, Spain, and Portugal defaulting. After this, without any recapitalization (see below), the European banking system's collective balance sheet would be deeper in the red than a seaport in a cranberry tsunami, and it's hello, Global Recession 2.0.

This is why authorities in Europe have been scrambling for the banks to "recapitalize" , i.e. to stock up their balance sheets with equity by selling ownership shares (often directly to the state), so that they can better absorb any losses from default (or from significant writedowns) if Greece indeed does take that route.

What would be the consequences within Greece of a default? They'd undoubtedly have to go off the Euro and back on the drachma, which would probably mean a major haircut for domestic savers. However, this may actually be the least worst of options for Greece. There is no way they can pay down their current debts and still function as a democracy: every round of austerity that gets implemented has a contractionary effect on the economy, which increases the debt-to-GDP ratio and actually drives the country deeper into debt in practical terms. The only way this debt could be paid off is by such drastic measures as could only be implemented under a military dictatorship, an institution which Greece has a bit of a history with. If they defaulted and returned to the drachma, getting credit on international markets would be like trying to get blood from a stone for a while, but the abandonment of the Euro would give them the extremely valuable recourse of currency devaluation: devalue the crap out of the drachma, thereby making Greek exports cheaper; start running a trade surplus, and credit markets automatically become a lot more congenial. (I can go into more detail on this last point if you want.) Within a few years things could be relatively back to normal; essentially the same thing happened with Argentina earlier in the century.

Hope this was helpful.
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