“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

– Mises

Nouriel Roubini calls Greece “the tip of the iceberg”.  PIMCO’s El-Erian says Greece is likely to default.  Greece is the news story that keeps on giving.  Unfortunately, the problems in Greece are persistent because the Euro has been a persistently flawed currency system.  Much like the gold standard, the single-currency-under-multiple-governments simply does not work in the best interest of all involved.  I have been racking my brain for several weeks now attempting to think of a good outcome in the Greek debt crisis.  As John Mauldin recently wrote, there really are no good solutions here.  I keep coming back to the same conclusion – Greece should leave the EMU and default on their debt.  It sounds quite extreme and could cause some very serious near-term panic, but in the long-run I believe the Greeks must do what is in THEIR best interest and that involves bringing back the drachma and taking control of their currency.   No country should ever relinquish the power to control their own currency and be their own banker.

Martin Feldstein believes the default in Greece is inevitable and like myself believes this has been essentially self imposed by the handcuffs that come along with being a member of the EMU.  Feldstein writes:

“Greece will default on its national debt. That default will be due in large part to its membership in the European Monetary Union. If it were not part of the euro system, Greece might not have gotten into its current predicament and, even if it had gotten into its current predicament, it could have avoided the need to default.

There simply is no way around the arithmetic implied by the scale of deficit reduction and the accompanying economic decline: Greece’s default on its debt is inevitable.”

By joining the EMU Greece essentially handcuffed themselves.  They are not their own banker and have no control over the issuance of the local currency. As I mentioned above the problems imposed on Greece by being a member of the EMU are similar to what nations have gone thru under the gold standard in the past.  A single global currency under differing governments simply does not work equally for each nation because each of those nations has different economies, different trade needs and differing monetary and fiscal policy needs.  Feldstein elaborates on the current errors in the EMU:

“Greece might have been able to avoid that outcome if it were not in the eurozone. If Greece still had its own currency, the authorities could devalue it while tightening fiscal policy. A devalued currency would increase exports and would cause Greek households and firms to substitute domestic products for imported goods. The increased demand for Greek goods and services would raise Greece’s GDP, increasing tax revenue and reducing transfer payments. In short, fiscal consolidation would be both easier and less painful if Greece had its own monetary policy.

Greece’s membership in the eurozone was also a principal cause of its current large budget deficit. Because Greece has not had its own currency for more than a decade, there has been no market signal to warn Greece that its debt was growing unacceptably large.

If Greece had remained outside the eurozone and retained the drachma, the large increased supply of Greek bonds would cause the drachma to decline and the interest rate on the bonds to rise. But, because Greek euro bonds were regarded as a close substitute for other countries’ euro bonds, the interest rate on Greek bonds did not rise as Greece increased its borrowing – until the market began to fear a possible default.”

While I believe default would be the most beneficial situation for Greece I am not so certain that they will be allowed to default.  The BIS shows that European banks have almost $190B in Greek exposure and would be unlikely to get more than about 30-40 cents on the dollar – that is an intolerable hit to already fragile European banks.  But I am certain that there is no pretty solution to the current problems.  After all, these are fundamental problems in the structure of the EMU.  It’s simply impossible to coordinate mutually beneficial monetary and fiscal policy under one currency when you have such differing governments and economies.  As a highly indebted trade deficit nation, Greece has substantially different needs than a country such as Germany.  By not controlling their own currencies these nations are unable to properly target the needs of their own economies and best service their citizenry.

Greece might agree to a bailout package, but this would likely result in years of painful austerity.  In addition it would do nothing to solve the structural problems of their monetary system – the fact that they cannot control their own currency.  This greatly increases the likelihood of future problems.  The next recession is likely to result in one or more nations confronting similar issues.   In that case, we haven’t solved anything.  We’ve simply kicked the can down the road.  Lastly, a Greek bailout assumes that these same problems won’t be confronted in the near future with Ireland, Spain, Italy or Portugal.  If Greece gets the rumored bailout it’s only a matter of time before other countries demand assistance.  JP Morgan estimates that a bailout of Greece, Spain, Portugal and Ireland would cost €600B or 8% of Eurozone GDP.

There really is no good solution here.  It was a mistake for so many nations with such vastly different economies to enter the EMU and this crisis is a glaring example. If I were the Greeks I would be looking into the cleanest and least damaging way to defect from the EMU, bring back the drachma and ensure that a foreign central bank never controls my people’s money again.  These are problems that Greece will confront again if they do not confront them now.  But let’s be honest here.  We live in a bailout world.  It’s highly unlikely that Greece will be allowed to default and that is perhaps the scariest scenario in all of this.  While it would alleviate near-term fears it does nothing but kick the can down the road.  In addition to years of a very weak and painful Greek economy it will also set the table for future bailouts and inevitable future problems within the EMU.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • SS

    Nobody fails in this global economy. Ferraris for everyone! Just print up some Euros!

  • LVG

    The emu is too large. I think it can work with the original 6 countries, but allowing all these small unstable economies in is a mess.

  • LVG

    Meanwhile, China closes down another 1%….

  • sean

    ECB could fund the whole 600bb today. The Euro might go down – very ikley would go down but so what. Its going down either way.
    Dont get me wrong. I think the system is a mess and unworkable buut if they want to keep it together they can. I don’t think they really want to or they would.

  • Patrick

    With all due respect, no one cares whether Greece defaults. All things finance have been kabuki theatre since the 80’s. Smoke and mirrors. In fact the vast majority of economists worldwide have not a clue about real world finance. Like global warmists, theirs is a world of computer modeling that has no relation to the real world.

    You think I’m wrong? How many of these economists/forecasters predicted anything accurate on a consistent basis for the last 20 years? That’s right none. Greece is irrelevant the minute economists/theorists say that it is important. Translated to market analysis–the consensus is always proved wrong.

  • ATP

    Default, bailout … just more deckchair shuffling on the Titanic.

    Without a change in their lackadaisical culture and sense of entitlement, the Greeks will not be able to compete and grow their way back, with or without bailout or default.

    Can they handle the truth?

  • chris

    push greece out or let greece defect and issue dracmas?

    this will never happen as long as french and german state owned banks own the majority of the $200B of greek debt outstanding to banks.

    they will want euros, even if they are simply printed to repay the outstanding credits.

  • gaius marius

    so was lehman not going to be a problem, if i recall correctly. lots of revisionism, but i had several convos with folks who all shouted “let it fail! this is capitalism!”

    i think the aftermath of a sovereign restructuring or two, and the fallout then visited on the european banking system as a result of that, will demonstrate just how much even a small but well placed country like greece or portugal can matter. the applicable lesson is that of the vienna creditanstalt in 1931.

  • gaius marius

    right. krugman has a good point here citing eichengreen — — greece might be able to leave the euro AFTER a banking disaster has struck and there’s nothing left to lose. but if it tries BEFORE, it guarantees a degree of capital flight that will sink the country into the aegean. no rational and informed greek politician can take that step. to be honest, only one country can leave the euro voluntarily, and that is germany.

    truth be told, though, capital must already be anticipating the increased probability of that endgame and fleeing en masse. maybe that precipitates the disaster that allows greece to leave.

  • TPC

    Reallistically, it cannot and will not happen for the reasons I stated. There is too much at stake for the surrounding nations. Eventually, however, Greece needs to leave in order to best serves its people.

    How this is done or when is beyond me. There is certainly no mechanism for it now….

  • gaius marius

    yeah. until/unless labor migration and cultural homogenization get a lot farther in the european mindset, all these countries would be better off ultimately with their own sovereign currency. no doubt. getting there fore here, though, you rightly say… it’s going to hurt.

  • Patrick

    My point is Lehman was not on the front pages of every finance site with the MSM broadcasting it for five months with every pundit screaming that they were going to default and the world was going to end.

    The only few who mentioned Lehman were the same folks who spotted derivatives for what they were years before and said it would lead to calamity.

    I have been hearing about Greece for what seems forever with all the usual bears chirping about the end of the world. The world may end but it will not be because of the Piigs.

  • blue monkey

    Greece and Spain won’t pay back. The only thing Germans can do is:
    REPOSSESS 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
    U.S.A must REPOSSESS 170 F-16 Jet Fighters from Greece, … the rest is gone with the wind …forever …
    Greece must stop paying lucrative pensions with borrowed money, reform the free health care system, and cut down, 4 times the military budged.

  • William

    This is like trying to plug one leak only to discover that you sprang another. What is most unsettling is, as Patrick mentioned, Greece being front-and-center and the object of everyone’s concern, thus resulting in the powers that be plugging the leak. If the can is being kicked down the road, then we can be sure that another leak will spring. In the meantime, complacency will resume until surprise! The masses are wholloped on the broad side by the highly improbable and unseen event. Not even Taleb knows what it will be.

    Notwithstanding, Greece does need to default. But whatever happens with the PIIGS, the effects will probably be muted. As long as the current world’s governments fight their battles with deficits, they are further burdening their people, prolonging the problem, and perhaps even intensifying the downside effects. From where the final blow will come is anyone’s guess.