Greece: the default calculus

Demonstrators in Athens on 19 June Image copyright AP

Who loses most from a Greek default? The common wisdom is that the biggest losers would be the Greeks themselves.

But, as my colleague Robert Peston noted, a Greek default would be no walk in the park for the rest of the Eurozone either.

In fact, though it suits European ministers to suggest otherwise, it could be argued that it's the rest of the eurozone that stands to lose most from a Greek default, which is why they are about to bail them out a second time.

For Greece, the reality is that all the options from this point are bad, but default only looks like the obvious worst option when you don't bother to compare it with the realistic alternatives. Otherwise, you might say it was a close-run thing.

Charles Dumas of Lombard Street Research is one who thinks that Greece would be better off defaulting AND leaving the Euro. What is more, he thinks that this option would probably be better for banks and other holders of Greek debt as well.

How so? Because he thinks that by enabling growth, default plus devaluation might actually raise the present value of those bonds, compared with the current scenario, which he thinks will mean default happening when the debt stock has risen that much higher and the economy has been hammered that much harder.

The thrust of his argument, which was also made by Willem Buiter last autumn, is that the Greek programme doesn't add up. True, other countries have achieved the kind of permanent budgetary adjustment that the IMF is looking for in Greece, but it is hard to find one that has done so without the benefit of a cheaper currency. You're talking about going from a primary deficit - that's the deficit, before interest payments on the debt are considered - of 4-5% of GDP in 2010 to a primary surplus of around 10% of GDP.

If that's not going to happen, Dumas says Greece will suffer more from prolonging the agony.

Others - like Wolfgang Munchau in Monday's FT - are sticking with the view that Greece is better off getting to a primary surplus before defaulting, so it wouldn't face an Argentina-style bout of further austerity as a result of losing access to international markets.

Who you side with on this depends, I guess, on whether and when you think Greece will actually achieve a primary surplus. The current program has it happening towards the end of 2012.

But amid the talk of the long-term cost of default, it's worth noting that countries can pay a penalty for NOT defaulting as well, not just in terms of slower growth but also higher interest rates.

An IMF study, based on the defaults of the 1970s, recently found that default added about 50 basis points, on average, to the offending government's medium term borrowing costs.

No surprise there, you might say. But a 10 percentage point rise in the national debt has been found to have exactly the same effect.

In other words, countries that run up large debts are damned if they do default, and damned if they don't.

If you're a eurozone official, avoiding a Greek default this week will probably always look the better option. The rule for governments everywhere is that a crisis tomorrow is always better than a crisis today.

But if you're Greek, the crisis has already happened. As their European benefactors are starting to grasp, that makes the calculation look rather different.