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If you analyze the Greece debt issue as a short term marketing problem for politicians the outcome becomes clear: Greece is going to default.

Defaulting is effectively a tax on the wealthy, asset holding class. Politically, this is very attractive compared to the draconian measures needed to avoid default. Politicans will choose to keep their jobs by defaulting, just like corporate executive keep theirs by going into bankruptcy and shafting bond and stock holders.

The only issue standing in the way of default is the ability of the Greek government to borrow after default. If this was a corporation, then there would be no problem gaining post bankruptcy financing. The issue is that the banks Greece owes today may be the ones needed lend to Greece post default and they may not be in existence post default.

However, capitalism works by profiting off the mistakes of others and a default by Greece eliminates the overhang of debt service so there should be ready capital for borrowing. The borrowing conduit is the question and most likely this will be done by the IMF with promises of austerity measures by Greece (but not as rapid as would be required without default) and the effective nationalization of home banks made insolvent by the default by other EU countries.

This will happen because it gets other EU countries off the hook with their voters by letting them concentrate on rescuing their own banks rather than assume the liabilities of a foreign government.

The big objection to this is that it would cause a financial crisis. Politically, financial crisis are no big deal as long as they are prevented from becoming economic crisis. As long as governments step in their role of as lender-of-last-resort to assure the smooth functioning of the financial process there will be no further deepening of the current economic crisis. The United States has regularly experienced financial crises that have had minimal (but not no) economic impact due to proper Government intervention, with the most notable being the Savings and Loan Crisis.

The other benefit of a Greek default is it would give European governments an excuse to finally clean up their banking system and start it lending again, a necessity that Salt Water, Fresh Water and Austrian economists agree on (though they disagree on mechanisms.)

If you doubt this is the probably outcome, look at Iceland/Icesave as a precedent. Icelandic voters are not going to accept responsibility for bailing out foreign investors and are prepared to vote for the effective default which is in their best interests.

Of course, the financial markets will take quite a hit from the realization that banks are effectively insolvent because countries can only be forced to assume so much moral hazard before the voters stop it. The dollar should strengthen further against the euro until this is resolved.

Disclosure: No positions

Source: Greece as a Marketing Problem