By Mike Patton, Forbes
Greece is a country on the verge of default. In a matter of a few months the world may well witness a Greek default of significant proportion. In this article we’ll clarify Greece’s position and explore the potential fallout if the country fails to repay its debt.
Greek Debt: An Overview
Most of the world is aware that Greece is mired in debt. Since the financial crisis emerged in 2008, the country’s financial stability has been tenuous at best. From early May to mid-September 2015, Greece’s required debt repayment is greater than 300 billion euros. Unfortunately, this is considerably more than its GDP. In fact, Greece’s debt-to-GDP ratio is 177.10. Given its rising debt and weakening economic activity, many believe Greece is headed toward an inevitable default. If this materializes, what might happen? Before we get into the details, let’s look briefly at the Greek economy.
The Greek Economy
Greece is facing difficult times. With unemployment over 25%, inflation at a negative 2.1%, and GDP hovering near zero, the outlook is bleak. When you incorporate its debt obligation, you have a recipe for economic calamity. Looking at the items above, Greece’s high unemployment rate requires little explanation. After all, it’s hard to propel an economy when 25% of its labor force is out of work. The second item, the negative inflation rate, may require some discussion. Since inflation is a measure of the change in the level of prices, a negative rate indicates that prices are falling. Although this may be perceived as good for the consumer, if it persists, deflation would result. During deflationary periods, consumers tend to hold off on major purchases and wait for a lower price. This reduces economic activity and causes GDP to fall, which can become a self-perpetuating cycle. If this happens, it can be very difficult to escape. For evidence, just look at Japan during the 1990s and 2000s. With Greece’s GDP straddling zero a recession is another distinct possibility. Given the myriad of issues facing Greece, more serious consequences could very well be lurking.
The Consequences of a Greek Default
What might happen if Greece were to default on its debt? In recent times, depositors have been pulling money out of Greek banks. If Greece were to implement some sort of restriction on depositors’ withdrawals, there would be a very loud outcry. Hence, civil unrest is one concern. Beyond that is the issue of systemic risk. In other words, banks and others who have invested in Greek bonds would be negatively affected in a default. Even though Greece is a small country, a default would still send shock waves throughout the global financial system. A Greek exodus from the Eurozone is also possible. Finally, interest rates in Greece would spike as investors demand a higher return for the additional risk.
Greece is attempting to restructure its debt…again and is in need of a capital infusion. If banks restrict depositor withdrawals mass panic and civil unrest would ensue. The greatest risk will occur around July and August as Greece is required to repay 6.7 billion euros to the European Central Bank (ECB). If it fails to repay the ECB or the International Monetary Fund (IMF ), Greek interest rates will spike, anarchy could follow, and this historic part of the world could become a hotspot for chaos and crisis. Let’s hope the Greek government and the ECB are able to find a solution. At this point it’s hard to see how. In this authors view, a Greek default is a near certainty. Therefore, it would be wise to position your investments in such a way as to minimize exposure to this part of the global financial system.
