US must understand that Greek default could lead to global crisis

One has to hope that the new administration is not complacent about the latest episode in Greece’s ongoing economic crisis. Unlike earlier episodes, there is every reason to think that this episode will not easily be resolved.

There is also reason to fear that this crisis is occurring at a very awkward moment for the European political economy. This heightens the risk that, well before this year is out, trouble in Greece could spill over to the rest of the eurozone economy, which could pose a serious economic challenge for President Trump.

At the heart of the latest Greek crisis, which has seen yields on two-year Greek bonds soar to over 10 percent, is a fundamental policy disagreement between the International Monetary Fund (IMF), Germany and Greece.

This disagreement relates to how much further budget belt-tightening Greece should undertake and how much debt relief Greece’s European partners should grant it if the IMF is to participate in future Greek rescue packages.

{mosads}Over the past two years, the IMF has made clear the conditions that would need to be met for the IMF to participate in another Greek bailout package. It has taken the position that there is a limit to how much further budget belt-tightening a battered Greek economy can reasonably be expected to undertake.

At the same time, however, the IMF insists that Greece must get serious about making deep structural economic reforms to put the economy on a better growth path. The IMF is also pushing Greece’s European partners to provide Greece with sufficient debt reduction to allow the country to be less draconian than it would otherwise need to be in terms of the additional budget belt-tightening required to allow Greece to service its debt.

Both the German and Greek governments disagree with the IMF, albeit for different reasons.

Germany is loath to grant Greece debt reduction before Greece makes further budget adjustment and it also believes that Greece is fully capable of indefinitely running a 3.5 percent of gross domestic product (GDP) budget surplus, excluding interest payments.

For its part, Greece believes that it has reached the political limits to any further budget adjustment that the country can make and that the Greek economy does not need further structural reforms.

In the past, similar such policy disagreements about the Greek economy have in the end been papered over by each of the three main parties having made compromises. A major factor that would seem to distinguish the current Greek economic crisis from earlier such crises is that for different reasons, each of the three main players currently appears to have very little room for compromise.

An embattled Greek government with slumping popularity cannot politically ask its weary population to swallow yet more bitter economic medicine. Similarly, ahead of German parliamentary elections in September, the German government can hardly be seen to be granting Greece debt forgiveness on the back of the German taxpayer.

For its part, with the IMF’s credibility in tatters and with a new and less European-friendly American president in office, the IMF would seem not to be in a position to again flout its own rules about debt sustainability to help bail out once again the Greek economy.

If none of the three principal parties to the negotiation moves soon, Greece will almost certainly default on its large debt payments coming due this July. That, in turn, would greatly heighten the probability that Greece would be forced out of the euro in short order, which could have important spillover affects to the rest of the eurozone.

At the best of times, a full-blown Greek economic and financial crisis would be very problematic for the European and global economies. However, these are far from the best of times for Europe, given its crowded electoral calendar and the rise of populism across the continent.

In March, the Netherlands goes to the polls; in April/May, the French have their presidential election; and in September, the Germans have their parliamentary elections. Meanwhile, with clear signs of political fracturing in Greece and Italy, it is all too likely that these two countries could be forced into early elections.

To date, the Trump administration has displayed a rather cavalier attitude toward the prospect of a possible breakup of the eurozone. However, the administration should be very careful about what it is wishing for. If the eurozone does come unstuck, we will almost certainly have a wave of sovereign debt defaults across Europe that would shake the global financial system to its very foundation.

For this reason, one has to hope that the new administration will soon grasp that a Greek exit from the euro could be the trigger that leads to the euro’s unraveling.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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