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Why Austerity Doesn't Matter: Greece Is Still Going to Default

Aris Messinis | AFP | Getty Images

This is how quickly the European debt crisis devolves: Austerity, viewed by markets as saving grace for Greece just a day ago, has quickly moved into irrelevance as banks and insurers continue to find a path around default.

No doubt cutbacks are an integral part of the Greek future.

Violent street protests aside, the county’s financial standing simply won’t allow it to continue along the path of bloated government, massive public giveaways and the debt-on-top-of-debt strategy it has employed for too long.

But without some type of structural default on its current obligations, all the austerity in the world won’t make Greece’s problems go away.

“Greece and a number of other European countries cannot repay their debt. In fact they will never be able to repay their debt under current conditions because their economies are not competitive globally,” banking analyst Dick Bove at Rochdale Securities wrote in an analysis. “Therefore, these countries must, and in my judgment will, repudiate their debt.”

Indeed, looking at Greece’s onerous debt maturity schedule, it is almost impossible to imagine another alternative.

Starting with a 2.4 billion-euro repayment on July 15, Greece then has to pay, in euros: 900 million on July 19, 1.5 billion on July 20 and 1.6 billion on July 22. August doesn’t get much better, when the nation has a 1.6 billion-euro payment due on Aug. 19 and 9 billion euros due to the next day.

“These dates and the respective maturing amounts point to substantial default risks in Greece without the continuation of its IMF-EU program,” Bank of America Merrill Lynch analysts wrote in a research note, referring to the ongoing bailout from the International Monetary Fund and European Union.

Default, for how ugly the connotation is, remains the least painful option in what will be an achingly long path back to prosperity for Greece.

The nation cannot hope to impose the level of Draconian cuts it would take to pay its debts without incurring a full-scale revolution, not to mention the punishing effects it would have on growth.

“It is time for the policymakers to think beyond the next debt repayment cycle and consider the core issues here,” Bove said. “If they do they will recognize that a default is inevitable and actually the best solution to the problem even though it will not seem so in the short run.”

The main problem with default, of course, is that it will lead to a financial crisis.

European banks with exposure to Greek debt will face capital shortfalls and have to go to market to raise money, driving up interest rates. American banks with exposure to the European banks will face the same fate as the US grapples with its own debt and deficit crisis.

The only question is a matter of degree.

Bove posits that there will be a “financial crisis” but not on par with what happened when Lehman Brothers collapsed in 2008.

But Julian Jessop, chief international economist at Capital Economics in London, thinks the Greek crisis could be akin to the collapse of Bear Stearns, the Wall Street bailout that turned public perception against bailouts.

“The upshot is that Greece certainly has the potential to become the sovereign Lehman. Policymakers might therefore conclude from the Lehman episode that Greece cannot be abandoned,” Jessop wrote in a note for clients.

“But the German public in particular is taking some convincing and the Greek people themselves may decide that the price of international support is simply too high. What’s more, even if Greece is rescued, the appetite and resources for another bailout would surely be limited. Greece might therefore end up as the next Bear Stearns–the last to be bailed out before patience runs out.”

Ultimately, then, Greece likely will come down to a political question that revolves around the expediency of a “voluntary rollover” of debt, as discussed Friday, or the reality of a default.

“There are no easy ways out,” Sebastian Mallaby, director of the Maurice R. Greenberg Center for Geoeconomic Studies, wrote in an essay for the Council on Foreign Relations.

“For more than a year, Europe's leaders have pretended otherwise, kicking the can down the road with stopgap measures. But voters in both Greece and the core countries are running out of patience. The euro, intended to unify Europe, is driving it apart. A crunch may be approaching.”

Jeff Cox is co-author, with Peter J. Tanous, of the recently released “Debt, Deficits and the Demise of the American Economy” (Wiley). The book asserts that the troubles in Greece will trigger a global financial crisis.

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