Reacting to a Greek tragedy

 

ECONOMICALLY, FISCALLY and politically, Greece is in dire straits. This is very bad news for euro and its 16 other participant countries. The single currency is only as strong as its weakest link. A further deterioration in the euro’s southeastern-most corner would have the most immediate repercussions in two of its other fragile corners – Ireland and Iberia.

But with Greece’s year-old bailout patently failing and its 18-month-old government looking increasingly shaky, something will have to give.

A large-scale restructuring of its sovereign debt would, in theory, offer it a fresh start. Greece’s public debt is heading towards 150 per cent of gross domestic product (Ireland’s is around 100 per cent). Its capacity to grow its way out of trouble is limited – it has few underlying economic strengths and many profound weaknesses. Relieving it of some of the debt seems the most straightforward way of pushing the reset button.

But, thus far, the most influential players in the euro area – Germany, France and the European Central Bank – have opposed any form of Greek sovereign debt restructuring. Although euro area countries have concerns about the direct losses default would impose on their own banking systems, which hold much of the debt, the primary motive for avoiding Greek default is the fear of unleashing the kind of panic that engulfed the world in late 2008. Then, the international financial system came perilously close to meltdown. As the system remains fragile and with states’ fiscal capacity to provide a backstop much reduced, governments might not have the wherewithal to prevent a collapse if it threatened again. Such a collapse would very probably lead to wealth destruction on a scale never seen before outside wartime. That is the worst-case scenario.

But would a Greek default really trigger such a doomsday chain reaction? The answer is that nobody knows for sure. That uncertainty, combined with the growing popular opposition to bailouts in the stronger northern European economies, is causing some policymakers and many commentators to advocate running the risk of an “orderly restructuring”. Adding to the case for chancing default are rising political instability in Greece and the growing likelihood that without debt relief it will require many years of being bailed out.

Irish politicians and policymakers will have little say in whether Greece defaults, but they need to prepare for the worst. If default happens and it triggers a meltdown, the social, political and economic consequences would – in the worst-case scenario – be of an order never before faced by independent Ireland. Over the past three years previously unthinkable occurrences have become almost commonplace. It would be gross negligence for the authorities not to plan for the worst.

But a more benign outcome should also be planned for. If a Greek sovereign default were to be absorbed by financial markets without causing meltdown, the case for sparing senior bondholders in Irish banks would all but disappear. If markets prove able to handle a sovereign default they will manage the restructuring of senior bank bonds. That eventuality should be planned for too.