Greek Sovereign Debt Default

by Jack Plumb and Uky Kim

The 2008 financial crisis devastated Greece’s already poor economy, and the Greek government is now on the verge of a default. A debt default is when a country is unable to pay its debts. The euro zone has been considering a bail out for Greece to preclude a default; however, the members of the euro zone are unable to agree on a plan. As of September 21, 2011, Greece’s debt is 366 billion Euros, which is approximately 160% of its GDP. On July 21, 2011, European leaders agreed to provide 109 billion Euros for the bailout. The potential effects of having the other euro zone countries bail out Greece could ripple across many countries’ economies; however, these effects would be minimal compared to those if Greece does default.

A Greek debt default would cause huge problems for the global economy because anyone who had lent money to Greece would lose most or all of their investment. For example, French banks that have purchased Greek bonds will lose most of their investments, causing many banks to lose huge portions of their reserves. This will drastically impact investments across Europe, because many of the impacted banks will not have the reserves to support lending, at least at low interest rates.

Because the impact of a default is so devastating and widespread, the euro zone will eventually bail out Greece; however, the other countries are waiting for Greece to do its best at recovery for two reasons. One, the other countries want to minimize the cost of a bailout by encouraging the Greek government to reduce its debt, possibly removing the need for a bailout altogether. Second, they want to wait for Greece to reform its tax system and labor laws, both of which are ineffective today. One effect the Greek default situation will have is setting a standard. Other countries, such as Spain and Portugal, which potentially have a debt default in the near future, will look to the Greek default as guide for their case.

It is obvious that Greece will need help getting out of this hole and back on track; however, there are several downsides to a bailout. First, the other countries in the euro zone, namely Germany and France, would have to pay for the bailout. Secondly, the bailout could cause the Euro to inflate due to an increase in the money supply. Although the bailout has its downsides, it is a better option than a default.

Sources

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"The Plan to Have a Plan: Solving the Euro-zone Crisis." The Economist 8 Oct. 2011. Print.