Oh would Greece just default already!

Oh would Greece just default already!

It has been over a year now since the European debt crisis touched down in Greece (after Iceland went bankrupt and Ireland had to be bailed out by the IMF). Every week brings another crisis or secret meeting in Luxembourg or riot in Athens or rating-agency downgrade. These developments have become as regular as clockword and yet have changed absolutely nothing.

As near as I can make out, a simplified version of the difficulty is as follows: Greece owes a lot of money to private banks, mostly in France and Germany. The loans have to be paid back soon but Greece can only get people to lend them more money (to repay the original loans) at usurious rates (currently 30% per annum on a 2-year bond, which is way higher than what a schmuck like me pays on a credit card).

Much of the wrangling is about deciding who is going to be short-changed when the music stops. If the lenders (the banks in France and Germany) are "made whole", somebody else has to pick up the tab. Because Greece can't, it falls to either national or pan-national governments. Does France have enough money to bail out its banks when their loans to Greece turn to dust? That means the French taxpayer is on the hook. Or does the European Central Bank help the various private banks out, in which case the people of Denmark and Croatia are sending money to keep the suits in Paris and Frankfurt happy? None of these are very palatable solutions.

Let us not forget the Greeks, who are stuck between a rock and a hard place. The austerity measures that the Greek government is being required to implement make the future look pretty bleak for most citizens. Sure, there was some loose accounting and (very) wishful (fiscal) thinking, but the regular people are not to blame for the poor management of previous governments.

Greece could simply default on its loans, leave the Euro zone, and go back to using the Drachma. This would lead to a pretty rough few years and a rapid decline in their standard of living, but that's what is now going to happen under the austerity measures anyways in order to satisfy the ECB. It seems to be a damned if you do, damned if you don't situation.

The thing is, this has been well understood for some time now. James Howard Kunstler's forecast for 2011 (now 6 months old) describes exactly the sort of pickle that the EU is now in:

The serial bail-outs engineered by the European Central Bank have been shams based on an imaginary "fund" that really only amounts to more promises of back-stops by bankrupt countries to other bankrupt countries. In the grand gesture last fall, around the collapse of Ireland, promises were made by the ECB to give the appearance that the usual suspects (the PIIGS) would cover their quarterly debt service obligations to March of this year. No real money was involved, only assurances, which will soon be revealed as empty. Bottom-line: another graver round of debt crisis in Euro-land in the first quarter if 2011.

     It can only be resolved two ways: by 1.) countries defaulting, dropping out of the Euro monetary system, returning to a currency of their own and activities that reality will admit; and 2.) Germany, France, and Holland taking the others in like poor relatives and paying their living expenses. I really don't see Number 2 working out. The voters in the bigger three economies will revolt. Of course, the Number 1 route implies the destruction of a whole bunch of European banks, perhaps all of them, and their shareholders positions, and big trouble for the wealthier Euro member countries - ultimately leading to the same place: a lower standard of living, even in Germany, for all its frugality and efficiency.

Back in October 2010 I attended a presentation in Ottawa by Nicole Foss of The Automatic Earth. I asked her afterwards whether she thought that the Greek debt crisis of May 2010 (that's a full year ago) had been successfully dealt with. Her answer was that things had simply been papered over and that the problem would re-emerge.

So it has been some time that smart people have been reading the writing on the wall. I think that even if this story has a happy ending with Greece paying back all its debts and the banks living happily ever after, it will only be a matter of a few weeks before the same debt crisis and escalating downgrades (down-scalating grades?) occurs in Portugal and/or Spain. Then it'll be another circus of special deals between Berlin and Brussels to insure that banks in Bruges don't bonk.

So Greece should default to put and end to this charade of a merry-go-round. It will suck for lots of people and the stock market will implode again. But it might give people a chance to regroup and rethink how Europe shares the Euro.