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Expert's Podium

The cure for Greece? Bankruptcy and the drachma Add to ...

It is difficult to see how Greece will ever be able to pay off the debt it owes.



Greece is the most indebted country in the world after Japan in relation to the size of its economy. But Japan has a large and productive economy and can rely on future growth to pay off its debts. Greece produces little more than tourism, agriculture and some industrial products. It has low productivity, high wages and high unit labour costs, and there is little in the future to explain how the country will be able to pay the debt it owes.

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By 2014, based on estimates by EconomyWatch.com's Econ Stats database, Greek debt will reach 150 per cent of GDP from about 125 per cent in 2010, surpassing even Japan.

And this number may be on the conservative side as some analysts estimate that debt is already marching toward 180 per cent of GDP. Based on current interest rates on Greek debt, even if the Greek economy grows by an optimistic 3 per cent a year, it will not be enough to pay the interest on the debt - and the debt will just keep growing and so will the debt-to-GDP ratio.



Of course, more efficient tax collection as well as a selloff of some government properties could help, but there is little political will or consensus on this - which means it's unlikely to happen.



It is in Greece's best interest to default on its debt. Markets have short memories and they will soon forget. If Greece fixes its finances, its economy and its attitude toward work and ethics, markets will happily accept Greece back to borrow-land.



A Greek default will, of course, be bad for Europe and will not make Greece many friends on the continent. It could lead to financial difficulties, even potentially to a default, of a couple of European banks that have large exposure to the Greek debt. However, defaulting on its debt obligations may be a better option for Greece in terms of averting major social unrest and possible economic collapse.



For obvious reasons, Europeans do not want Greece to default. Many European banks, especially German and French banks, are on the hook if Greece declares bankruptcy. European governments are thus trying hard to help Greece and prevent such an event from happening. But they are hesitant to push Greece too hard.



They want Greece to keep trying to prevent a default by introducing a variety of austerity measures that, nevertheless, are less severe than Greece's predicament calls for. But even these relatively moderate measures have so far created a precarious situation for the country as the continuous salary reductions, cutbacks and other austerity measures are becoming political suicide for Greece's governing party. The knife has hit the bone, as they say in Greece, and there is not much more Greeks are willing to give. So it will be either social unrest or bankruptcy.

Best-Case Scenario



The best scenario would be for Greece to declare bankruptcy, go back to the drachma, and devalue its currency. This money illusion will make Greeks feel better in that their salaries will not get cut in drachma terms even though in essence they will be poorer as all imported goods will cost more. But impressions are everything and the perception of lighter austerity measures may prevent social unrest. At the same time, exports will become cheaper and the Greek economy more competitive, which will boost Greece's efforts to repair its economy.



Greece has already lost its economic sovereignty and is under economic occupation by the European Union, the International Monetary Fund and the European Central Bank, known as "the Troika." Greece's financial system is in such a precarious situation that the cost of remaining in the euro zone may be higher than the cost of what I suggest above.



Although defaulting is easy to explain, make no mistake, it will not be easy to carry out. There may be a run on the banks and some smaller Greek banks may need their own bailout. Some banks may default as they will have difficulty accessing money markets. That is why before this happens Greek banks should be encouraged to merge to become stronger and more viable.



Greece should use its time outside the euro zone to fix its economy and make it more productive. After 10 years or so it may decide to reapply for entry, especially if the euro zone puts in place better mechanisms to help the poorer regions of the EU.



If Greece uses the time outside euro zone cleverly and efficiently it will have a future, if not, it will not. It is that simple.



George Athanassakos, gathanassakos@ivey.uwo.ca, is a Professor of Finance and holds the Ben Graham Chair in Value Investing at the Richard Ivey School of Business, The University of Western Ontario.





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