Tuesday, May 10, 2011

The ongoing Greek problem

The choices for solving the debt crisis are actually very clear. Austerity or default. At some level as debt levels reach an extreme, the choice is singular, default. This case is simple. If the size of the debt is greater than GDP and the rate of interest is greater than the growth rate of the economy, all of the economic growth and then some has to be used to pay interest to bondholders. Extending maturities woud not help. Lowering interest rtes would be helpful but only if the rate would be below economic growth.

This extreme is where we may be at with Greece, but we will have to continue to play this issue out because the lenders have an incentive to avoid the default. The Greeks at this point may welcome default as an alternative to more years of austerity. There will be an adjustment but the would like to go forward in a different environment than what exists today. Taxes have to be paid and services reduced in order to pay bond-holders.

A restructuring is needed and bond-holders are going o have to take a hit. This could be pushed forward a little longer but the end result will be the same.

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