What will happen when Greece defaults

The economic impact will pale in comparison with the political backlash.


IT IS not only the fate of Greece, but also that of an entire continent which hangs in the balance, as heads of state and governments from the European Union get together today for a special summit in order to avert the country's bankruptcy.

A last-minute deal which averts Greece's eviction from the euro currency zone is still possible. But there is no doubt in the minds of all European leaders that the margin of error which separates a durable financial deal from a catastrophic financial crisis remains painfully thin. Europe is facing its biggest political test in decades.The behaviour of financial markets resembles the psychology of crowds: it's prone to bouts of panic attacks. So, there is no fail-safe way of calculating how Europe and global financial markets will respond to Greece's potential bankruptcy; fear of the unknown is the key reason European governments have tried to avoid the prospect of a Greek default for years.

Nevertheless, it's clear that if no deal is done, the country won't leave the euro zone out of its own free will; the Greek government will simply default on its debt repayments but still insist that it remains inside Europe's single currency area. By taking this stance, Greek Prime Minister Alexis Tsipras will not only be shifting the blame for the crisis on the rest of Europe - a tactic he has pursued since he came to power at the start of this year - but he will also be preparing for the political battles which await him at home.

Other European leaders will also be keen to avoid personal responsibility; no EU prime minister - and particularly not the German Chancellor - wishes to go down in history as the man or woman who tore Europe apart. The pressure will therefore grow on the European Central Bank to act, by simply declaring that it is no longer prepared to support the Greek banking system, which is in any case already moribund. The result of such an action will be almost instantaneous: the Greek government will have to order the banks shut, impose capital controls in order to prevent cash from fleeing the country, and contemplate the introduction of a new currency.

Yet, quite apart from the fact that such a currency will have to be printed, the Europeans will have to decide whether an eviction from the euro zone also means an eviction from the European Union. In theory, it does: according to the existing treaties, the euro currency is irrevocable, and the only way a country can abandon the euro is if it leaves the EU altogether.

The coming backlash

IN PRACTICE, however, the EU will find a solution to keep Greece in, probably by declaring that Greece is "a member state with a derogation", a legal term already applied to the former communist countries of Eastern Europe which are in the EU, but for a variety of economic reasons not yet in the euro zone. That will hide the scale of the Greek rejection, and also hold out the prospect that Greece could return to the euro zone, once it got its house in order.

Still, that won't be sufficient to avert the backlash which will follow. The economic pain inflicted on Greece will be appalling. A newly introduced currency will sink like a lead balloon, regardless of the rate it is pegged to the euro; estimates compiled by the International Monetary Fund suggest an instant devaluation by as much as 50 per cent in comparison to its initial trading value, pulverising the bank savings of most ordinary Greeks.

To make matters worse, the traditional benefits of a devalued currency, which include higher revenues from tourism and a boost in exports, won't work in Greece. A rise in tourism income would quickly be wiped out by rising inflation, while Greece exports little. And paradoxically, far from reducing the country's debt repayment burden, an exit from the euro zone could actually increase liabilities, because Greece currently benefits from a deferral of payments on most of its loans, something which will no longer be available.

But all this pales into insignificance in comparison with the political backlash. For most ordinary Greeks, the euro is not simply a currency; it's a symbol that their country, which often languished on Europe's geographic and political margins, has succeeded in becoming an equal member in the club of rich nations.

Eviction from the euro zone will, therefore, not only be a deeply humiliating event, but it will also be seen as the failure of an effort undertaken over almost two centuries to transform Greece into a mainstream European nation.

Massive demonstrations against a political class which is seen to have betrayed this dream are inevitable, and some violence may also be directed at foreigners, and especially at Germany which, absurdly, is blamed by many ordinary Greeks for their predicament. Current contingency plans by some EU governments include preparations to evacuate their citizens and temporarily vacate their embassies in Athens, the Greek capital.

Russia's chance to split Europe

A SERIOUSLY weakened Greece will blow a hole in Europe's immigration policies; many illegal immigrants already pour through its porous borders. It will also spell a vast expansion in European corruption and organised crime: a Greek government which is already incapable of collecting its own taxes is unlikely to succeed in imposing capital controls over a nation rendered penniless by the crisis.

Tensions between Greece and Turkey, historic rivals for many decades, will also rise, especially since the Turkish government is facing major difficulties at home, and may be tempted to wave the flag of nationalism. The real flashpoint may well be Cyprus, the island-state which is already divided along ethnic lines between Greeks and Turks.

Then, there is Russia, which relishes the opportunity to embarrass and split Europe; it's telling that Greek Prime Minister Tsipras chose to spend the end of last week not in urgent discussions over his country's fate, but on a trip to an economic forum held in Russia, where he was received as a hero. There are persistent rumours that, in return for cash, Russian President Vladimir Putin would wish to establish a harbour for his navy, the ultimate snub to Nato, to which Greece belongs. If European leaders find Greece annoying now, they'd better be prepared to discover what true annoyance really means.

And although fears about the potential impact of a Greek eviction from the euro zone on the finances of other European countries are probably exaggerated, there is no doubt that the "risk premium" which other countries will have to bear, namely the extra money they will have to pay for their borrowing, will increase, as investors calculate that, if one EU country can default, so can others. The risk of a financial contagion from Greece is, therefore, substantial.

But, as strange as it may seem, that's not necessarily an argument for accepting any compromise to save Greece from bankruptcy, for that too also carries with it the risks of contagion, albeit one of a different kind.

The Greeks have persuaded themselves that they shoulder almost no responsibility for their disaster, that the crisis is due to the devilish plots of foreigners - and particularly Germans - who somehow persuaded previous Greek governments to borrow and now have the effrontery to demand their money back.

The Greeks also believe that the crisis facing them is one entirely due to debt, when in fact debt repayments are only a tiny part of Greece's financial burden; the country's real problem is that it has been an almost failed state for decades, spending far more than it ever proved capable of collecting in taxation, and borrowing to make up the difference, because generations of venal, corrupt and irresponsible politicians found this easier.

The current Greek government won power on the dishonest proposition that Greece could keep the euro, but pay nothing for it, that the expectation of the Greek voters should trump those of other Europeans, whose tax money is now being used to prop up Greece. Giving in to such a Greek government will merely encourage other populist movements which are arguing the same thing in Spain or Italy.

And if Greece is allowed to get away with this defiance, the chances of imposing any discipline on other countries in the EU disappear. In short, the argument that evicting Greece out of the euro zone is too risky tends to ignore the fact that keeping Greece in the euro zone is equally risky.

Since European governments are so split about what they should do, a Greek default, if it becomes a reality, will come by default, more as a result of financial markets getting fed up with this crisis. So, even if Greece survives today by concluding a deal which provides it with some additional cash, this will only be a respite of a few months, before the same crisis resurfaces, and the spectre of default returns, because there is no indication that Greece wishes to mend its ways.

The nation which invented both the concepts of drama and tragedy seems set to drag the entire continent into both.


A version of this article appeared in the print edition of The Straits Times on June 22, 2015, with the headline 'What will happen when Greece defaults'. Subscribe