Solon’s ghost: Greek default scenarios

The latest this morning is that the EU is trying to shoehorn Greek government asset sales. This could provide both the opportunity to pay down some public debt and boost productivity, helping the rest of the economy better handle the debt left over.

However, I’m not yet reassured by these measures. It’s not at all clear to me that the EU attempts to force asset sales onto the Greek government won’t make the core problem worse. That is that the European crisis is political, not economic. As Houses and Holes pointed out this week, the EU can centralise its fiscal functions or create a centralised bank recapitalisation mechanism (a kind of partial fiscal integration) but both are political solutions that look far distant.

Fact is, we all know what the alternative solution is to Greece’s problems. The Greeks’ themselves know, having exercised it many times in the past. It’s to default. To purge the system. Hugely devalue the currency and rebuild.

The question has to be therefore if a Greek default seems inevitable why hasn’t it happened yet?

The answer is that politicians are scared. They are scared of the forces that a clumsy Greek default will unleash. They are fearful that having seen a Greek default that the Irish may question why they are allowing the EN to tug their forelock and enduring a debt burden and austerity that will see their grand children still paying their bills. They are equally concerned that the contagion unleashed will not stop at Ireland, Portugal or Spain but inevitably target the much larger economy of Italy and even the core countries.

If this happens then there will be nowhere to hide. Not here in Australia, not the USA nor Japan, certainly not the Shanghai stock exchange  – perhaps on a small farm on the South Island of New Zealand or our outback somewhere but only if you don’t need money or access to it to get by. Because make no mistake 4 years after the start of the GFC the global financial system is once again in a very fragile state and a mishandling of a Greek default will precipitate GFC II.

This may seem an extreme picture to be painting but history tells us that the system and economy must cleanse, perhaps purge is a better word, before a sustainable recovery can begin. As  the fiscal and monetary stimulus fades in the big developed economies and as China and its developing cousins seek to reign in their economies default looks like it is becoming the rational option for individual nations and their people.

My base case for some time has been that a politician somewhere in one of these jurisdictions would advocate the repudiation of debt once it became clear the population was with him. Greece has a history of default so it will not it is that unusual for them, having happened repeatedly over the past 100 or so years. Indeed Greece has an even richer history of the release of debt burdens with Solon having instituted widespread debt relief of the Athenian population 6 centuries before Christ with the Seisachtheia. I still remember the quote from school all those years ago which culminated in “which men call the seisachtheia for they shook off their burdens”

So if it’s rational for the Greeks to default (and in turn the Irish and others) the question therefore is at what cost do they shake off these burdens.

1. Best case, hoped for by the muddling through hopefully moribund European Political class – Extend Greek debt profile by 5-10 years (longer if it can be arranged) which the market accepts as not a default (because they’ll get their money eventually) and we all move on. Ireland stays the course, Portugal likewise and Spain is a non-issue.

ECB and European banking system avoid any serious stresses

Likelihood of success – less than 10%

Likelihood they’ll try – probably >50%

2. Base Case, considered by European politicians and Central bankers but assumed to be manageable – option one of “debt re-profiling” undertaken but market agrees with Fitch that this is a default and marks Greece’s card accordingly with CDS and spreads to German Bunds exploding northward.

The market then goes hunting for Ireland and Portugal raising the cost of their borrowings to levels where they too look for option 1 as a way out. Spain teeters as it’s next in line and politicians call for calm and stand ready to support the countries and banks under pressure. Attention turns to the UK banking system and fiscal situation.

Likelihood that this may occur – probably > 50%

3. Worst case, currently not canvassed but in the back of the mind of the next Solon – Greek PM announces unilateral withdrawal from the EUR and default on its debt effective immediately at 12 midnight one day soon. Harking back to the time of Solon the Drachma is re-introduced at a substantial discount to the 340 rate it went into the EUR.

Global markets go into meltdown. The contemporary interconnectivity of global banks means no one lends because they don’t know who is holding Greek, Irish, Portuguese, Spanish, British or German debt.

Governments are unable to help because there is no fiscal space.

We have GFC II and global recession – but now the economy can heal and the loses are made by the generation that created the debt or made the bad investments

Likelihood that this may occur – probably < 20%

In many ways its Hobson’s choice – there is only one answer possible, default. But the outcome of a default and the impact that it has on the global economy remains uncertain because we don’t know which way the future will unfold. But in uncertainty circumspection is key and markets are getting that now. The tragedy of the commons is however thus, traders and investors acting in their own rational self interest are increasing the pressure on the Greek, Irish and Portuguese populations and politicians to act in theirs. That means default and the forces that this will unleash.

Latest posts by _EcoRon_ (see all)


  1. I will take Box 3. It will be short and sharp. A mess to begin with but hopefully all the idiots that have these debts (including certain aussie banks) come clean and then everyone can get on with it.

    Box 1 .. it sounds like an oxymoron.

    Box 2 .. if it sounds like a dog it is a dog.

    The Euro can survive, if and only if they (EU) alter their charter. Currently each country has a currency union with no fiscal union.

    For PIIGS and UK to leave this union then great. Let them sort out their crap with their old currencies, inflate to buggery and get on the straight and narrow again. Maybe the powers that be may be able to tell the truth. Each were far to eager to jump in for the benefits and lied about everything.

    Totally out of left field though, is that some really bright politically junkie will allow a International Bank to be backed by all countries and issue one reserve currency and allow all other currencies to be pegged to it. Not necessarily a AU reserve status but with support from the G22, overcomes the problems associated with political football called the Euro and US Bernanke’s stupid policies.

  2. Nice article….i’m def in the “it’s better to just default and start over camp” —–> long-term it’s a much better solution imo.

  3. Great overview DFM. Continue to be impressed by the quality of articles here on Macro Business.

    It concerns me how little the average joe knows about the current risks we face over the next couple of years.

    Whether scenario 3 is triggered by Greece or something else I think it’s the most likely scenario and may not be far away!

  4. Great post DFM. Up to this point the markets appear to missing/ignoring that the Euro-debt mess is fundamentally political. The punters seem to understand they are being foisted with the fallout from the fun and games played by the finance houses, and at the same time the bond-holders are trying to walk away without a scratch. Yes the practical cost of default is high but the failure of the financial institutions and bond holders to share the costs is becoming a bigger issue than the potential down-side from default. It’s not going to take opportunistic politicians long to realise that in the short term option 4 might be a winner.

  5. Option 1 or 2.

    Greece is holding a gun to every one’s head by implementing option 3 and I’m sure will privately tell EU/US types they will pull the trigger. EU dudes will freak.Will do everything they can to maintain the fantasy.

  6. Before Solon repudiated the debts of the Ancient Greeks, Solon’s friends took out loans and bought land around Athens. I wonder if the same type of thing is happening now.

  7. “Fact is, we all know what the alternative solution is to Greece’s problems.”

    Skeptic/hopeful at first, I now see and understand that there is no way out of a Greek default/restructuring. I’m still hoping it will be a controlled one, if only to maintain pressure on Greece to go ahead with some much needed changes.

    What worries me a bit is that a default is consistently labelled on this blog as being a ‘solution’ to Greece’s problems. I see that as the equivalent to saying that a government stimulus is what we need now to solve the Australian housing market problem. The problem in Greece is mostly cultural and will require more than a default to solve.

    As I stated before I remain convinced that both the Euro and the EU will survive this crisis, even in case of a Greek default. In fact, I think that well into the future this may be regarded one of Europe’s defining moments as the current crisis opens up (political) opportunities for fiscal and monetary integration. In that regard this crisis may revive the European integration process which was so effectively slowed down by the French and Dutch in referendums about the European constitution.

    One example of new political opportunities resulting from the crisis (the EU quite openly interfering in domestic policies):

    Some interesting info on Greece’s plans to sell some of its assets: