Every few months we get another installment of the Greek credit crisis and another installment of the market jitters that go along with it. The jitters are understandable. Another global credit panic would certainly harm the world economy.
Size MattersHowever, the Greek economy is tiny compared to the worlds larger economies. Greece's GDP is approximately $300 billion. That is about 1/50th of the US GDP or twice the annual sales of General Electric. We are certainly not talking about peanuts, but objectively a $300 billion economy is not large enough to damage the world economy.
The same picture emerges when we look at it in terms of debt. Outstanding Greek government debt is about $460 billion.This is clearly unsustainable given the size of the GDP. Since Greece cannot unilaterally print Euros to pay its debts (i.e. inflate it away), the only way out is default.
Little ImpactHowever, even if Greece defaults on all of its obligations, which is unlikely, it would cost the bond holders or the EU tax payers about one and a half times the cost of bailing out Fannie Mae and Freddie Mac ($317 billion). More realistic scenarios would probably cost about the same as bailing out the mortgage companies. Again we are not talking about peanuts, but we are also not talking about amounts large enough to derail the world economy.
The real risk is not that Greece defaults. It is that the market participants react so strongly to the continuing uncertainty that the financial system grinds to a halt. This would transform a manageable problem into a big one, and could triggering a default of other overextended countries such as Spain, Belgium, or Portugal.
European politicians should stop pretending that Greece can become viable through austerity measures alone. Those are absolutely necessary, but without the ability to inflate away debt, they will most likely not be sufficient.
A Greek default would certainly shock the markets, but it would also provide clarity once the shock wears off. That clarity is necessary for financial markets to return to normal. The sooner that happens, the better.
Posted by Martin Gremm