Greece’s situation is dire and it faces three ugly but realistic options, according to Peter Boone of the London School of Economics and Simon Johnson of MIT.
One is to embark on an austerity program—a true austerity program, not the cosmetic fix-ups that the Greek government has already announced. Greece would have to chop its government spending by 10% of GDP. If it chooses this option, the pain over the next two to three years would be intense. Expect strikes, violence, political chaos.
The second option would be to default on the country’s debt but keep the euro. If this is what happens, foreign lenders should expect to lose 65% of the face value of their loans, which would imply huge losses at many European banks. And Greece would still have to cut its government spending.
The third option is for Greece to default on its debt and exit the euro. This is the option that may make the most sense, since it would allow Greece to peg a new currency at a much lower level than the euro to restore competitiveness. But it would be a slap in the face to the European political elite and it would still mean pain for many European banks.
Boone and Johnson say the one option that doesn’t make sense is for Europe to try and muddle through with help from the International Monetary Fund. The problem is simply too big for that. Greece’s ratio of debt to GDP is already 114% and will rise to 150% by 2012. At current rates, servicing this debt would mean that Greece would have to transfer 9% of its GDP to debt holders in other countries for years to come. That is not going to happen. Better face the problem now, say Boone and Johnson, than try to kick it down the road.
Freelance business journalist Ian McGugan blogs for the Financial Post