What Happens If Greece Falls Off the Debt Cliff?

Reading 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.