Greece: deflate or default

The original worry was whether Greece would default. Then it became a question whether it should it default. Now it is a question of how it will default. To hazard a guess, I should think that after the wizards of Brussels determine how much of a default is necessary to keep German (et al.) bail-out money forthcoming, the only remaining question will be when the default will occur. It is clear that the vast majority seem convinced that default is the only option, or that it is the best one, or, at the very least, that it is the most expedient one at this time.

Default is not a word to throw around casually. When an individual defaults on his mortgage, it involves great pain – he loses his house, his car, and whatever other assets he posted as collateral. Default does not mean that debts are forgiven and he starts afresh (although the vulgar form of default seems to imply this). Default causes our individual pain – it is something that he tries to avoid at all costs.

Before the Greek default occurs – which is increasingly becoming a foregone conclusion – we must look at two facets. First, what will this default mean? Second, is there a better way?

A nation can default two ways. Implicitly, by inflating the real value of its debt away by increasing the money supply, or explicitly, by not paying back the full value of its debts. If the eurozone is to continue to include Greece as a member, it is clear that an implicit inflationary default is impossible. (Some commentators seem to belabour this point, as if Greece exiting the euro and inflating away its problems would prove a panacea.) With this avenue gone the attention focuses on the explicit default, soon to be delivered.

Haircuts imposed on creditors form what seems to be the preferred planned default. In reality, a haircut only allows for one-half of a default to occur.

The half that we will see is the pain imposed on creditors. Lenders kind enough to loan their funds to the Greek government likely never expected that they would not be repaid. At least, they likely never expected the extent to which they would not be repaid (which could be as little as 20 to 50 cents on the euro). It is easy to take solace with caveat emptor, but that is only half the story.

If I default on my house, it is not only my bank that suffers a loss; I must as well. I must lose all available assets in an attempt to make my bank as whole as possible. There are not so many plans to sell Greek government assets to pay for its debts (of course, the related question is whether anybody would want such assets. I am sure that few creditors would rather take a union-saddled Greek government agency, complete with strike-induced headaches, rather than cut their losses at 100 percent).

If Greece wants to default, it must abide by the rules of the game. The current “default” plan for Greece is nothing of the sort; it is a gift. Few Greeks seem willing to sacrifice sovereign control to foreigners by relinquishing assets, and perhaps rightly so. But if assets will not be sold to try to cover its debts, Greece must look for a different avenue to default.

Cutting expenditures is one path. While Greeks strike at the very thought, if the choice was clear to them – lose sovereign assets to take a cut on your pension – their attitude might quickly change. Creditor nations avoid this trade-off by being ambiguous as to what a Greek default would actually mean to Greeks. This very ambiguity makes the game continue longer than it must. As excessively high expenditures are what got the country into the mess to begin with, it seems to be a logical place to start to try to exit recession. Austerity might be a dirty word, but it is a necessary one.

There is one other option left to the small Hellenic republic. It is not without precedent, but it too is a dirty word in some circles. Greece may not be able to pursue an external devaluation through inflation, but she can pursue an internal devaluation through price decreases. Deflation might cause some to run to the exits, but it is increasingly proving its worth. Ireland has recently started exiting its recession through deflation, and occurrence making it ever less likely that the country will default. Deflation is not necessarily easy – public and private workers will have to take salary cuts, austerity programs will have to be intensified (and fulfilled!) – but it allows the country to avoid the costs of losing national sovereignty and creditors taking losses on their loans. Some may think deflation is a dirty word, but no more than the alternatives. And it has already been successfully tested in other ailing European economies.


  • mrg says:

    I’m not sure I follow the bit about deflation, but I disagree with your view of sovereign default.

    “Lenders kind enough to loan their funds to the Greek government” ? Is kindness really the right word here? And supposing so, is it noble to be kind to the Greek government at the expense of the Greek people?

    Like Rothbard, I think that government debt is fundamentally different from personal debt, and thoroughly immoral. It should be repudiated in its entirety, and we should no more feel sorry for government creditors deprived of their ‘investment’ than we’d feel sorry for slave owners deprived of ‘their’ slaves.

    Nor do I see why default should entail any loss of sovereignty, unless creditors to the Greek government are able to persuade their governments to go to war over the matter.

  • Ted (Greece) says:

    I’m from Greece. People are getting more and more politicized and many of them are signing up with the leftists. Radical left (two parties) has reached 10% and another 10% is on the stalinist left. Right-wing anti-free-market parties are starting to rise again and the two main political parties (conservatives, liberals) are in an awful mess.

    Mrg, you’re right on Rothbard’s take on the government loans, these things are keeping our economy down, funding our little nanny state is not an act of kindness.

    But things are more complicated. 30% of our loans are on our banks and insurance funds. So defaulting is deflating, in our case, and an extreme danger for the national banking system.

    Greek government assets, tangible assets, are out of the question for almost all Greeks. There’s no logic that a banker has to take an ore of an island because the politicians thought hiring their voters in the public sector is for free. Almost half of the population doesn’t even care to vote. Government agencies are totally useless and non-competitive, as they are, (they are based on mandatory monopolies which sooner or later they’re gonna end), so what will the lender take, the buildings? Unions are gonna destroy them then. (Squattering in public buildings is all the rage lately)

    The most dismal aspect is that the E.U. is taking the decision on when this default, or haircut, or whatever, is going to happen (though thank god that Greek politicians aren’t allowed to play with this thing too !, but… ) but they are moving slow, and the EFSF is becoming a bail-out machine. This has got to stop cause it’ll cause inflation in the end and cause there are so many “malinvestments”, as you call them, that are suffocating the market!

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