The Independent Market Observer

What Happens If Greece Falls Off the Debt Cliff?

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Jun 12, 2015 2:03:00 PM

and tagged In the News

Leave a comment

greeceReading about the Greek debt crisis this morning, I think it’s high time to resurrect the once-ubiquitous “cliff” metaphor from the U.S. budget negotiations.

The faceoff between Greece and its creditors continues to intensify and is now worse than the confrontation between Republicans and Democrats ever was. There are very real and substantial divides between the two sides, and the parties involved are running out of room to agree to disagree.

Greece may not be right at the edge of the cliff—a temporary agreement buying another month or so remains possible, even likely—but it’s not that far away. News that the IMF recalled its negotiators suggests that at least one major party has essentially given up. Quotes from European negotiators suggest that they, too, have more or less thrown in the towel.

In thinking about a post-default environment, there are two periods we need to consider: the immediate aftermath, which would be painful and messy, and the longer-term effects, which could be even messier but likely not as painful.

Economic vs. political issues

The real questions here are not economic but political. This, in fact, is the core of the problem—economically, Greece simply can’t pay its debts, so it needs to write them down, but its creditors can’t allow this, for internal political reasons.

On the positive side, a default would mean that Greece might be able to reduce its debt to a supportable level, allowing it to resume growth. It would still face the same competitive problems it always has, but it would at least be able to work them out without the prospect of an immediate crisis. A default would go a long way toward solving the economic problem Greece faces.

At the same time, though, it would create enormous political problems.

Of greatest concern, if Greece defaults on its debt, will it be forced to leave the eurozone? There is reportedly no provision for expelling a country from the zone—it was meant to be irreversible—so Greece may, in theory, remain even if it does default. Polls show that the Greeks want to stay (as indeed they should), so the question will be whether Syriza leaves in a fit of pique, or whether Germany tries to drive Greece out.

Short-term consequences and beyond

So, what can we expect if Greece defaults on its debt?

  • Short-term, a Greek default would be disruptive and painful. We’ve recently seen the effects in stock markets, which have bounced and dropped with each rumor. There are very real systemic risks, which I hope will be contained.
  • Medium-term, the issues will be political and much more consequential. If Greece were to leave or be forced out of the eurozone (or, even worse, the European Union), the world would change significantly, especially for Europeans.

Let’s put this in perspective: Countries can and do default on their debt. Greece has been doing it for hundreds of years. Economically, this is neither new nor a big deal. The politics is the problem, and that just comes down to talking. As with the U.S. fiscal cliff, the problems are big but eminently solvable, and disaster is not guaranteed. 

In any event, here in the U.S., we are well positioned to ride out the storm. There will be turbulence, and the stock market is already reacting. Expect to see apocalyptic headlines—“Dogs and cats living together!” to steal a line from Ghostbusters—just as we did with the U.S. fiscal cliff. As then, though, the U.S. should get through this crisis just fine.

Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®