In September, I looked at how the only real first step to solving the European sovereign debt crisis was to admit that Greece was completely broke and that the country would need to default on its debt. Even after a whirlwind couple of weeks filled with countless plans to shore up the struggling European periphery, we still have no idea how Greece is actually going to deal with its debt load. Sure we've come closer to an official admission that bondholders won't get 100 cents on the euro, but plans for a voluntary write-down of debt keep getting derailed by politics. Even with a new government in Athens, the path forward is not clear.
But it remains vitally important to get the painful default process started. It could help remove the incredible uncertainty that is rocking the markets and help create a credible road map for other troubled European states.
Greece Is Insolvent
With debt standing at 143% of gross domestic product at the end of 2010 (and that number has gone nowhere but up given the country's budget deficit), Greece will never be able to pay back its creditors 100 cents on the euro. The only way that the country can become solvent is to cut a huge amount of spending, for growth to pick up considerably, or for the government to find a way to meaningfully raise revenue.
None of those seems likely. As the United States is discovering, cutting spending is incredibly tricky. Greek citizens are already revolting against the proposed cuts, which won't even fully close the budget gap for years. Any deeper cuts would likely mean the collapse of the government, and any new regime won't find the task of cutting spending any easier.
On the growth front, Greece doesn't have a particularly competitive economy, and much of the growth depends on government spending and subsidies. As these payments decrease, growth is likely to contract even further. With economic woes spreading across much of the world, the chance that expanding gross domestic product will save Greece is approaching zero.
Adding revenue might be even harder. Tax evasion is rampant across the country, and there isn't much appetite to pay even more in taxes in order for banks to get bailed out. Passing new taxes is therefore unlikely to have a major impact because many of them might go unpaid. Changing the culture of compliance is not something that is going to happen overnight. Novel ideas such as adding a tax to property owners' electric bills and other fees might help somewhat but can only do so much.
Plans to sell off publicly owned companies and other assets to raise funds have faltered, as well. Foreign firms don't want to deal with the minefield of labour and political issues that would come with acquiring one of these firms. Add in the negative outlook for Greek economic growth, and there just won't be that many takers even if big discounts are offered.
The only way to stave off the default then is for the rest of the European Union to pour bailout funds into the country. However, these structural problems are not going to be solved by some short-term cash that will need to be paid back at reasonably high interest rates. Kicking the can down the road doesn't do anyone any favours. The uncertainty surrounding Greece is a big problem. Without any clear indication of when the crisis is going to be over, investors are going to be very jittery every time a bad piece of news comes out.
It's better to rip off the proverbial Band-Aid now. Greece will take its lumps, but it will then be able to begin the long process of reconstruction and the rebuilding of the economy. In default, the country can make the structural changes needed for long-term stability.
Can the Contagion Be Contained?
Unfortunately, nothing is that simple. The big fear all along has been that a Greek default would set off a chain reaction that would force a slew of larger economies such as Italy or Spain into bankruptcy, as well. Avoiding the real problems for so long has already helped push Italy into full-blown crisis mode and the rest of Europe might not be that far behind. The contagion cat is already out of the bag.
However, just because the crisis has spread doesn't mean we should give up on trying to save the larger European economies. Italy, for example, has a much stronger economic base than Greece, and it would be possible to craft solutions that would allow the country to reform and be able to pay its obligations. It's not a very persuasive argument that Greece should be propped up because it will somehow help Italy. In fact, the more attention and energy spent on maintaining the fiction of Greek solvency is only making it harder to focus resources on where they could be used best.
And surely a disorderly non-negotiated bankruptcy would make things even worse. It would steal focus and resources away from other countries and could put an unbearable amount of pressure on already-teetering economies elsewhere. It would be far preferable to take control of the situation, create a negotiated managed default, and do it soon.
Now of course, the default will be no magic bullet. The euro could very well be in tatters after the country defaults, and the problems facing the rest of Europe won't magically disappear. It's certainly possible that the Greek default would set off a chain reaction that would bring the global financial system to its knees yet again. We just don't know. However, the options are not default on one hand and no default on the other. At this point, it's really just a matter of what the default is going to look like. Better to have a well-executed and thought-out plan than to wait until another crisis forces the issue. Europe's leaders need to step up to the plate and make the tough choices.
What do you think? Will a Greek default help sooth Italian fears? Will there be hidden consequences?
Bearemy Glaser is the worry-prone alter-ego of Morningstar.com markets editor Jeremy Glaser. Each week, Bearemy will share what's topping his list of concerns and invites you to reply or add your own in the comments section below.
