What Happens If Greece Defaults?

Its possible that we are approaching the end game in the long running debt crisis in Europe. On any rational basis, Greece is already in default. It is almost wholly reliant on the bail-outs it has received from the EU, and IMF just to cover its current running costs, including the costs of paying the interest on its existing loans. Its private sector creditors have already agreed to write-off 50% of the loans they have made, and now the current discussions are about increasing that figure to 80% plus. The question is not really about what happens if Greece defaults, but about what kind of default it is. But, the other question is, if Greece did have a disorderly default would the consequences for workers across Europe, be as catastrophic as is being portrayed?

In his blog Paul Mason, writes,

“I understand the IMF believes a "sustainable" settlement needs an 80% plus write off - and the IMF rules do not allow it to sign off deals that are unsustainable.”

In a sense, this shows the nature of the real problem. If Banks and Finance houses can write off more than 80%, of what they are owed by Greece, then it shows that in the big scheme of things, those debts in themselves are not that significant. What is significant, is the fact that if Greece has a disorderly default, then that will trigger claims by Banks and others on the Credit Default Swaps they have bought with other Financial Institutions, which are a bet that Greece WILL default. The amount that these institutions might have to pay out on these CDS bets, could be many times what the actual Greek debt is. That creates massive instability and fear because, no one knows who is liable to pay out, on these bets, how much those bets are, and so who themselves might become insolvent. It is what led to the Credit Crunch after the collapse of banks like Northern Rock in 2007, and particularly after the collapse of Lehman Brothers in 2008. Already, the exposure of European Banks, and the fear that, unlike US Banks, which were nationalised and recapitalised in 2008/9, those Banks do not have sufficient Capital to withstand such an event. Already, that has caused interbank rates in Europe to rocket, many foreign Banks will not lend to them, and other global businesses will not deal with them. It was to deal with that situation that the ECB, with help from the federal reserve and other Central Banks, made available €0.5 trillion a few weeks ago to provide the European Banks with liquidity. So, the problem is not a Greek default as such, in fact, a lot of the Greek and other peripheral debt that was on Banks Balance Sheets, has been transferred to the Balance Sheet of the ECB over the last few months, because the ECB has been printing money to buy peripheral Bonds in the secondary markets, and the sellers of those Bonds, will have been the European Banks. The problem is a disorderly default.

The problem is that the actions of EU politicians, particularly German politicians, seems to be driving inexorably towards such a disorderly default. It was obvious more than a year ago that under current conditions, austerity measures could only have a negative effect. Perhaps the biggest problem for a country like Greece is not the debt, but its inability to generate the income to pay it off. The same cause is what leads to the debt in the first place, the inability to cover your expenditure from your income. In the new global economy, that is a problem for all developed economies, as they confront the expanding power and competitiveness of China and other new, dynamic economies. Austerity can only act to contract the economy, and create the conditions under which businesses are loathe to invest, because they can see no possibility of selling what they produce. What Greece really needed was a massive injection of new Capital in the same way that West Germany provided for East Germany, and other East European economies after 1990. But, with a growing European recession, it is not just Greek businesses that will be reluctant to invest. That is why we see around the globe, not a crisis of overproduction of Capital, but a massive hoarding of Money, which does not re-enter the Circuit of Capital, but sits in Bank deposit accounts earning low rates of interest, but whose owners are happy to take it, because they have become concerned with return OF Capital, not return ON Capital.

Paul Mason continues,

“Numerous hedge funds are reported to have bought Greek debt so as to operate in the space of uncertainty this opens up, much as a gambler operates next to a roulette wheel. If the "haircut" is 80%, I am told, many of them lose money and are prepared to trigger credit insurance contracts that will then torpedo the entire deal. They will not lose money as a result, but the European banking system will go into crisis.”

The actions of Germany's politicians, at first sight seem perverse. Almost every global economist, almost every organisation representing the interests of the global Capitalist class – IMF, World Bank, OECD, NIESR, S&P – as well as numerous think tanks, and business groups, have pointed out that the policy of austerity is not working, and that measures to stimulate growth are vital. Yet, Merkel continues to echo the views of Cameron and Osbourne that yet more austerity is needed! But, as I showed recently in relation to Cameron, thinking about this in Marxist terms, rather than crude Economic Determinist terms, makes this not at all difficult to understand. Economically, Germany has every reason to desire stimulative measures in Greece, and other parts of Europe. Germany's economy, and the prosperity of its workers have been built on being able to export to these European economies, and the existence of these other economies in the Eurozone, has meant that the value of the Euro has been lower than would have been the Mark, providing German exporters with a competitive advantage.

But, the picture that has been painted across Europe, is that the crisis in Greece was caused by a profligate government, and workers who retired too early on too high Pensions etc. That was never true. The real problem for Greece, as with other economies in Europe, including Britain and Ireland, is that low interest rates encouraged investment not in productive activity, but in blowing up speculative bubbles in shares, property etc. The cause of Greece's problems is not Greek workers, but Greek Capitalists. However, having established this narrative, just as the Tories have established the narrative that Britain's problems are due to overspending by Labour, and high wages and pensions for workers in the State Capitalist sector, it creates its own dynamic. Any attempt by the Tories now to reverse course will undermine their narrative, and mean that people will quickly catch on to the fact that they were conned by the Liberal-Tories. In Germany, with elections due, Merkel faces a similar problem. The SDP and Greens, who look set to win in the next elections, are both in favour of the creation of EU Bonds, and of the ECB acting as lender of last resort to stand behind it. If Merkel wants to have a chance of winning, she has to have a different narrative. Given that the CDU appeals to that same kind of strata in Germany, that the Tories appeal to in Britain, it is quite clear that to maintain electoral support, she has to be seen to be demanding fiscal responsibility by those who Germany is bailing-out. Of course, there is another reason for Germany to push this line. When a new European State is established, Germany will be the economic power at the heart of it. Ultimately, it will have to be the force that provides the financial ballast for that State. It has to ensure that other economies will not simply leach off it. That is why Germany is insisting on a level of fiscal responsibility that is unlikely to be maintained once such a state is established – the Maastricht criteria were not adhered to, and Germany was one of the first countries to breach its requirements.

But, if Germany continues to push in this direction it may well push Greece over the edge, making all of those plans redundant. Paul Mason writes,

“Not free are Merkel, Monti - because constrained by politics in Italy - and the Greek government. The latter have, off the record, briefed that the IMF's proposed austerity programme means "civil war". The most likely outcome of next week is they accept a fudged austerity programme that then does not work. One Greek commentator put it to me like this: "the people who sign a deal that gives away Greek sovereignty over debt that then goes wrong have to be prepared to be court-martialled". He wasn't joking.”

He may be right. Much of what has happened over the last year or so has been for public consumption. Many of the deals were done on the basis that an agreement to undertake various austerity measures would provide the justification for agreeing the latest bail-out, without any expectation that the measures would be fully implemented. That has bought time during, which the Banks and Financial Institutions were able to off load their Bonds to the ECB, and other Central Banks. Money Capitalists have been busy off-loading their potential losses on to workers and productive Capitalists, whose taxes will be expected to cover the losses. That is why they have been pulling money out of not just Greece, not just the peripheral economies, but even out of France.

So, what if Greece does go through a disorderly default? It would mean that money would be withdrawn on a huge scale from Ireland, Portugal, Spain and Italy overnight, with probably France, and other potentially vulnerable economies following suit. Claims on CDS's would escalate, probably bankrupting huge numbers of European banks, which would inevitably have a knock-on effect on US and other international Banks. It would create a Credit Crunch much more severe than that of 2008/9. Of necessity, such a credit crunch means that money stops being made available for businesses, consumers, homebuyers etc. As in 2008, it would mean that share prices crashed, and along with it house prices, as all asset prices are revalued, Banks raise mortgage rates severely, and begin a firesale on all properties where there are arrears, to prevent a capital loss in a collapsing market. Given the scale of the property bubble in places like the UK, and Spain (still) it could see property prices fall by 90%. The stopping of credit to business would inevitably lead to a sharp contraction of economic activity.

But, its important not to get too carried away by all this. There is a general misconception that the Great Depression was caused by the 1929 Wall Street Crash, and that a similar Financial Crash now would have the same result. But, the Great Depression was NOT caused by the Wall Street Crash. It may have acted as a trigger, but the real cause of the Depression lay with the ending of the Long Wave Boom that ran from the late 1880's, to 1914-20. It was that, which led to the onset of a period of low growth for Europe, which saw a number of economic crises during the 1920's, and 1930's, of which the Great Depression of 1929-33, was merely the worst. In 1987, when there was an even sharper sell-off on the Stock Market, it did not lead to a more severe economic crisis than had already existed from the late 1970's. So, the fact of a financial crisis and a revaluation of assets is not at all the same thing as an economic crisis, based upon an overproduction of Capital, particularly one associated with the termination of a Long Wave Boom.  And, today we are in the first half of a Long Wave Boom, not downturn.

A Credit Crunch does not affect all aspects of economic activity in the same way. For example, the drying up of credit is important if you are a small business dependent upon credit for working capital on a day to day basis. But, nearly all big companies have huge cash balances out of which to finance working-capital. It may lead to a drying up of consumer credit, but under current conditions, where households have huge amounts of private debt, and they are attempting to deleverage, that should be less of a problem, because, the demand for credit itself should decline. One means of that deleveraging may well be that large numbers of people themselves default on their private debts in the same way that countries might be led to do. In that way, the real burden would fall on those Money Capitalists who have been lining their pockets for the last 30 years, during the period of Neo-Liberalism, and who are largely responsible for the current debt crisis.

Of course, it is always portrayed that such a crisis will have terrible consequences for ordinary workers. But would it? If small businesses go bust, because of lacking working capital, its possible they might be taken over by a bigger company, which tends to provide better conditions for workers. If not, with a large scale devaluing of Capital Assets, it would be easier for the firm's workers themselves to take it over, and run it as a Co-op. Such a derating of Capital is always portrayed as meaning big losses for workers in their Pension Funds, but is it? The Value of the Fund might fall sharply, but Pensions are mostly paid out of the income the Fund receives not from Capital Gains made by the Fund. As a consequence of what is called “Pound Cost Averaging”, massively falling share prices, will mean that workers contributions into their Pension Funds, will buy many more shares than they did previously. Moreover, as the price of shares falls dramatically, the Yield on those shares, the percentage of dividend to share price, will rise sharply. Because, Pension benefits tend to be paid out of this Dividend Income, the potential arises for being more able, rather than less able to cover future pensions. The same is true with Pension fund investments into Bonds.

At the moment, the fear in the global economy means that owners of large amounts of Money are prepared to put it wherever they think it is relatively safe. That means that the price of Bonds in countries like the US, the UK, Japan who are able to print money to cover their debts are unsustainably high. Moreover, it is the actions of those States in printing money with which they buy their own debt, in order to pump liquidity into their economies, which also forces the Yields on those Bonds down, whilst at the same time, pushing inflation up. Once the event that is causing the fear has gone, the basis of that will disappear. The owners of Money will be able to look at investing it where it might bring in a reasonable return. Once the fear has gone, after the debt crisis explodes, businesses will once again be able to plan on investing, and be able to utilise some of those vast stores of Money – at least $15 Trillion in the US alone – waiting to be invested.

The real losers in such a process will be the Money Capitalists who over the last 30 years have rule the roost, and who have drained Surplus Value away from productive capital, both directly, and through the turning of workers into debt slaves. The Money capitalists through the links they have, and the power they exercise over right-wing parties like the Tories have been able to protect themselves from that denouement. Workers should not be conned into believing their interests are served by a continuance of that. In fact, were workers to obtain control over the funds in their pension Funds, such an event that put Money Capital in its place, could be highly beneficial to workers, who would be able to pick up huge amounts of productive capital at low prices. And a fall in house prices of 90%, would go a long way to resolving the current housing problems by making houses once again affordable for first-time buyers.

In 2008, the International Co-operative Alliance put out a statement arguing that none of the Co-operative and Mutual Banks across Europe had been affected in the way the Capitalist Banks had. If huge swathes of Capitalist Money Capital was wiped out, it would open the door for a huge expansion of those Co-operative Banks. And, as I argued a year or so ago, over the collapse of the Irish Banks, rather than the Capitalist State bailing them out, the State should have just protected the deposits of savers, whilst the Banks were allowed to go bust, and their workers take them over to run as Co-ops, taking over the assets of the Bank.

Rather than being a threat to workers, properly armed with the idea of workers taking over bankrupt capitalist property and running it themselves as worker owned Co-ops, a Greek default, and the subsequent devaluing of Financial and other assets, could provide workers with a golden opportunity.