What Happens When Greece Defaults? [Global X Funds, Vanguard FTSE Europe ETF]

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June 24, 2015 3:06pm NYSE:GREK NYSE:IEV

greeceJim Bach: What happens when Greece defaults?


That’s the question on the market’s mind right now. It’s no longer a question of  “what happens if Greece defaults?”

The Greek debt crisis has roiled on for close to six years now with no clear end in sight. As the International Monetary Fund, the European Central Bank, and the European Commission – the troika – continue to haplessly pursue a policy of piling bailout loans on top of an already deeply indebted Greece, a breaking point has to be reached.

Greece can’t repay its debts. A Greek default is the only option.

IMF staffers knew this in 2010 before then-IMF Chief Dominique Strass-Kahn silenced those internal discussions and endorsed the bailout solutions.

But default talks are no longer secluded to IMF backrooms or private meetings between European financial authorities. The discussions of a Greek default on its €328 billion ($367 billion) in debt – a 175% debt-to-GDP ratio – and even “Grexit” are now mainstream.

Greece Will Default

Right now Greece is in discussions with the troika to negotiate the disbursement of a €7.2 billion ($8 billion) tranche in bailout loans from existing €240 billion ($268.7 billion) programs authored in 2010 and 2012. Without the release of those funds, Greece can’t meet debt maturity and interest payments on loans coming due.

The back-and-forth right now is more political theater than it is a good-faith effort from either side to resolve the crisis.

The troika claims it wants Greece to get its fiscal house in order with deep structural reforms, privatization, and painful-but-necessary austerity measures to trim the Greek budget. The Greek public, however, blames the austerity conditions attached to bailout loans for deepening the crisis and further impoverishing the country.

The newly elected leftist Syriza party in Greece was swept into office in January on populist voter sentiment. Syriza, led by Prime Minister Alexis Tsipras and Finance Minister Yanis Varoufakis, insist on the global stage they’re coming to the table with meaningful blueprints to cut the budget and release the loans.

The troika disagrees.

In reality, Greece is trying to project one image to Europe – that it’s hard at work trying to appease creditors – and another to its people – that it won’t fold to the unrealistic demands of European bullies.

“Varoufakis wants to make it very clear that any expulsion from the euro, if it occurs, is going to not be Syriza’s fault, but it will be Europe’s decision,” distinguished research professor of economics at the University of Missouri-Kansas City, Michael Hudson, told Money Morning. He wants to paint “Greece as the victim of foreign economic aggression.”

The troika is wary that if Greece defaults and exits the euro, it will have the potential to threaten both the reputation of the Eurozone and will throw the global balance of power into upheaval.

With the stakes so high, what happens when Greece defaults?

What Happens When Greece Defaults?

At first, very little.

Greece is 2% of the Eurozone economy. Its debt is largely in the hands of official institutions and not private creditors.

You may see some vulture funds that have bought distressed Greek debt fruitlessly take Greece to international debt courts like they did with Argentina. And you may also see a small payout from protection sellers in the credit default swaps market.

But as far as a wide-scale economic collapse, the chances are slim given Greece’s size.

What frightens the Eurozone is that even though Greece is small in the grand scheme of the European Monetary Union, it has more leverage in negotiations than it’s given credit for.

There’s the contagion effect a Greek default could have. Portugal, Italy, and Spain – also indebted Eurozone countries – may see Greek default as a signal that fiscal profligacy in Europe bears little consequence and follow suit.

Hudson said Greece is “an object lesson.”

when greece defaults chart

Right now, the troika is merely acting as an arm of the European bank lobby and demanding harsh austerity measures to make Greece feel the pain of its past budgetary indiscretions.

“The lobbyists say, on principle, nobody should be able to default,” Hudson said. “What they really care about are Spanish debts, Italian debts, and Portuguese debts. And they’re saying, ‘Don’t think you can default because we’ll do to you what we’re doing to Greece.'”

The debt of those countries is much larger and more concentrated in private hands and default would have the potential to spark a broader financial panic.

But there’s another, more disastrous consequence if Greece not only defaults, but exits the euro…

Greece will be driven into the arms of Russia.

This is just as Europe, the United States, and the North Atlantic Treaty Organization are trying to devastate Russia economically with sanctions over its arming of pro-Russian separatists in Ukraine.

You see, Greece and Russia have intersecting energy interests.

“Russia has become reliant on Greece for its strategic natural gas pipeline that will cut through Turkey, then into Greece, to eventually deliver into Europe,” Money Morning Global Resource Specialist Peter Krauth said. “It’s a multi-billion euro deal that has Greece salivating.”

This is a move that would not only undermine NATO and bring Russian influence to the EU’s doorstep, but would also deprive the troika of a prize it’s long been after in this push for Greece to sell public assets and cut its budget.

“The European Central Bank wants them to privatize the gas resources,” Hudson said. “But to Europeans, not Russians.”

A Greek exit from the euro would make Tsipras – who called Russia one of Greece’s most important partners while speaking at the St. Petersburg International Economic Forum last week – more susceptible to cut a deal with Russia.

“If Greece were to be forced out of Europe it’s going to say ‘Okay, we’re going to either stay in NATO and block everything you do by veto… or we’re going to be out, and… we’ll make a deal with Russia. We’re going to get by one way or another,'” Hudson said.

So what happens when Greece defaults is not of much economic concern, at least immediately. It’s of geopolitical concern, and it could give Russia an upper hand in what’s become a revival of Cold War politics.

Bottom Line: The world is not concerned about Greece and Europe is not concerned that a Greek default would hurt the Greek public. If the Eurozone were concerned about that, they wouldn’t have piled unpayable loans and austerity on top of an already impoverished country. The problem is that Greece could emerge a stronger economic player with Russian patronage. Not only does that prompt other indebted Eurozone members to pursue the same path, but it also tilts the global balance of power in Russia’s favor.

Money MorningWritten By Jim Bach From Money Morning

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