Why It Won't Be a Tragedy if Greece Defaults

European leaders are working around the clock to prevent a Greek default -- as if they had a choice.

European leaders have been scurrying around for quite some time in an effort to prevent a Greek default. But all the activity has obscured two fundamental questions: Is it even possible to prevent Greece from defaulting at this point? And would a default really be as calamitous as so many seem to think?

European officials certainly appear spooked. They have agreed to a €130 billion bailout package and are now talking about increasing it to €145 billion if the Greek government implements austerity measures and private holders of Greek sovereign debt voluntarily agree to steep reductions in both principal and interest. They have been hatching schemes to keep the European Central Bank (ECB) from having to join private investors in taking a loss on its Greek bond portfolio. And they have been erecting a massive firewall of liquidity through the European Stability Mechanism, the International Monetary Fund (IMF), G-7 central banks, and the ECB in the event that markets dry up and eurozone countries and banks need cash. So far this week, Greek political leaders have failed to satisfy the demands of the ECB, IMF, and European Commission for the implementation of proposed austerity measures.

Why so much sturm und drang? What's the alleged downside of a Greek default?

For one thing, the ECB would have to write off €55 billion in Greek sovereign debt, which would reduce the central bank's ability to meet liquidity needs. The losses would have to be replenished by additional contributions from member governments (i.e. Germany).

For another, European banks would have to write off their own €50 billion in Greek debt, which might reduce bank capital to dangerous levels and scare off short-term lenders. Without sufficient liquidity, banks would be unable to pay off short-term debt as it matures. They might then either fail outright or be bought out by national governments (i.e. nationalized).

Other financial institutions would be in jeopardy as well. European, American, and Asian insurance companies would have to pay out on credit-default swaps (insurance) to investors who have hedged their bets against a Greek default. This might leave such companies vulnerable to dangerously low capital reserves and potential bankruptcy, with possible knock-on effects.

But the most terrifying consequence of a Greek default may be the contagion effect, in which the bonds of other relatively suspect economies -- Italy, Portugal, Spain -- come under attack and create liquidity problems that lead to sovereign bankruptcy.

These scenarios, however, rest on the faulty assumption that there is a choice of saving Greece from default, even though numerous studies suggest otherwise. They indicate that Greece will default despite the best intentions of European leaders. The country's debt burden of 160 percent of gross domestic product (GDP), combined with its failure to rein in public spending and an economy that has been shrinking for five years, make default a virtual certainty. Banks lend money to those who need time, not those who need money. And Greece cannot repay its debts, no matter how much time is allotted. The question, then, is whether Greece defaults sooner or later. Later may give European leaders time to buttress a firewall against further contagion. But it could also lead to a colossal waste of resources by throwing good money after bad.

All of this begs the question: Why not just let Greece default? If Greece is a terminal patient, why not save €145 billion in bailout funds for healthier patients?  Injecting Greece with euros is a palliative measure that relieves suffering but does not cure the patient, merely delaying the inevitable instead. The eurozone remains in critical condition as long as Greece continues to drift in and out of consciousness on life support.

In the grand scheme of things, Greece is relatively small potatoes. Its economy is less than one-tenth the size of Germany's and accounts for only 2 percent of the eurozone's GDP, and its €350 billion in debt amounts to only 4 percent of total eurozone debt. The tail is wagging the dog.  Granted, there is a possibility that contagion will spread and deplete the liquidity of other euro members, but this is a remote and manageable risk.

The more likely fallout from a default would be Greece dropping the euro. Without the possibility of external funding, the government will have to cut public spending to no more than tax revenues permit. But tax revenues will be in free fall because of capital flight, a taxpayer revolt, and a rapidly contracting economy. Austerity measures will be necessary, but no government will last long enough to put these measures into effect. Faced with such catastrophic economic failure, Greece will have no choice but to return to the drachma.

Fear of contagion is essentially built on a domino theory. Back in the 1970s, the lack of predicted consequences following the American defeat in Vietnam falsified the domino theory in the realm of international politics. Communism did not spread to neighboring countries, nor did the United States have to defend its borders along California's coast. Now it is time for Greece to falsify the theory in the realm of international economics. The firewall that European leaders have been building over the past year is designed precisely to isolate other eurozone countries from the effects of a Greek default. It is meant for those countries that face a liquidity problem, not a solvency problem. Greece is a different matter; it is insolvent. Until the gangrenous limb of Greece is amputated from the eurozone body politic, contagion will spread to countries such as Italy, Portugal, and Spain, which will kill off the euro.

All of this, of course, assumes that eurozone states will harmonize their policies regarding pension reform, unemployment insurance benefits, and public sector spending cuts to achieve reasonably balanced budgets. If not, even without Greece, the euro is finished.

There are at least two other major caveats to a recovery of the eurozone, both of which remind us that the euro is essentially a political project, not an economic one. In France, all bets are off if the Socialists win presidential elections this spring. Efforts to reduce government spending at the expense of public sector unions would cease. Cooperation with Germany on fiscal discipline and austerity measures would go out the window. And the euro would disintegrate.

In Germany, Chancellor Angela Merkel is already pushing the envelope. German taxpayers will only do so much to pay for the sins of their more profligate neighbors. Although European politicians are reluctant to confront the prospect of a Greek default, European publics are not. Street demonstrations against austerity measures in Athens have produced equal and opposite reactions in Berlin, where Germans are demanding an end to the regime of bailouts and "too big to fail." Faced with this grassroots resistance, parties in the Bundestag are already refusing to consider additional funds for Greece. Merkel and her Christian Democratic Union coalition must listen to these demands or face the wrath of voters. If pushed too far, Merkel's government will collapse. Its replacement is likely to be both less cooperative and more intransigent on the issue of the euro.

If the European debt crisis has taught us anything, it's that the era of easy money is over. To ensure the eurozone's survival, the ECB will have to make new distinctions between national bank borrowers. Banks from countries with low credit ratings (southern tier) will have to post higher quality collateral than banks from countries with high ratings (northern tier). Portuguese, Spanish, and Italian banks must no longer be permitted to use their sovereign debt as collateral for new loans.

This restriction will inhibit the kind of unlimited credit expansion that led to the real estate bubbles in Ireland and Spain and extravagant public spending and chronic budget deficits in Greece, Italy, and Portugal that spawned the current crisis. It will enforce market discipline on states that routinely run budget deficits or embrace unproductive economic policies. Such discipline will reduce overall sovereign debt and strengthen bank balance sheets. The risk of sovereign default will be transferred from eurozone taxpayers to private investors. This reform is not a panacea, but in the absence of full economic and political integration, where a European identity is sufficiently advanced to allow transfer payments from one nation's citizens to another's, it will have to do.

Sean Gallup/Getty Images


Freezing in the Dark

Europe's energy demands exceed what Russia can produce, and this latest cold front proves the continent has no strategy for fixing the problem. Is shale gas the solution?

It is getting to be a European winter tradition. In 2006, 2009, and now again in 2012, temperatures plunge, and Russia interrupts its gas supplies. But while this spectacle is sadly familiar, Europe's response continues to be hampered by internal divisions, Moscow-friendly European gas companies, and the Kremlin's clever machinations.

Europe's deep freeze is no laughing matter. Heavy snow fell in Rome for the first time in a quarter-century, Venice's canals have begun to freeze, and temperatures in Ukraine have plunged as low as -32 degrees Celsius. As a result, more than 300 people have died across the continent.

Russian gas exports have dropped by 15 percent as its own consumption has soared in the cold weather -- meaning there's less to go around. Deliveries to some countries, including Austria and Bulgaria, have been reduced by as much as 30 percent, and Russia accused transit country Ukraine of siphoning off more gas than it was entitled to. This time -- unlike the 2009 supply cut, which arose from a pricing dispute -- the cause of the shortages seems to be that Russian gas monopoly Gazprom simply does not have enough gas to serve both its domestic and international markets, and Prime Minister Vladimir Putin reportedly ordered the company to prioritize Russian consumers.

The United States may have turned "energy independence" into a populist rallying cry and boosted its own gas production dramatically, but European countries have gone in the opposite direction. They have concentrated on trimming demand, developing renewable energy sources, and striking individual deals with Russia. Germany's shutdown of its nuclear plants and Italy's decision not to restart its nuclear program post-Fukushima will further increase Europe's reliance on Russian gas.

This strategy has made Europe more vulnerable to the deep chill currently seizing the continent. But it doesn't have to be that way: Europe's shale gas resources, though probably not on the scale of those in the United States, could be a substantial local energy source. Some estimates suggest that Europe could possibly have 15 trillion cubic meters (Tcm), a figure that would be more than double the continent's current conventional gas reserves.

The challenges of developing these resources are as much political as they are scientific. The possibility of shale gas development has met with opposition from environmentalists, lukewarm enthusiasm at best from politicians, and behind-the-scenes obstructionism from Gazprom and the European gas giants that benefit from a close relationship with it. In 2010, showing a touching concern for the environment, Gazprom deputy CEO Alexander Medvedev told Britain's Telegraph, "Not every housewife is aware of the environmental consequences of the use of shale gas. I don't know who would take the risk of endangering drinking water reservoirs."

In Bulgaria, these veiled warnings were heeded. The country, which was badly affected during the 2009 cut off, buys gas from Gazprom at more than four times the price in self-sufficient North America. Bulgaria's Ministry of Economy estimates it could have 100 years worth of shale gas, and polls suggest 75 percent of Bulgarians support shale gas exploration with appropriate environmental safeguards. Yet in the fastest-moving legislation it had passed since the communist era, Bulgaria voted to ban "fracking," an essential step of releasing the gas from shale, and ended U.S. oil giant Chevron's license for shale gas exploration in the country's northeast.

The move was led not by the Environment Ministry but by the head of the parliamentary economic committee, Valentin Nikolov, who was allegedly influenced by Russian pressure over renewal of gas contracts which expire this year. Energy Minister Traicho Traikov claimed that the campaign was led by a "motivated elite" and the rightist Union of Democratic Forces accused Gazprom of "serving the same role that the Soviet Army served some decades ago." The ban perpetuates Bulgaria's almost complete dependence on Russian gas, and discourages other shale gas explorers from risking their capital in Eastern Europe.

Bulgaria is far from the only European country to shoot itself in the foot on energy independence. France, which may have some of Europe's richest shale deposits around Paris -- containing oil as well as gas -- had already banned fracking in June last year over environmental concerns, as have two Swiss cantons. These bans came despite a European Commission study stating that "neither on the European level nor on the national level have we noticed significant gaps in the current [shale gas] legislative framework."

European incumbent companies have been mostly negative about their home turf's potential, leaving shale gas development to their competitors. The shale charge in Europe has been led by small companies such as Cuadrilla, which announced a find of almost 6 Tcm in northern England last year, and U.S. giants such as ExxonMobil, Chevron, and ConocoPhillips.

Meanwhile, to pre-empt Europe's attempts at supply diversification and to avoid being held hostage by transit countries, Russia has advanced new pipelines. Nord Stream, which runs under the Baltic directly to Germany, began deliveries in November. Weeks after stepping down as German chancellor in late 2005, Gerhard Schröder became chairman of the committee of Nord Stream's shareholders, who, with Gazprom, include two of Germany's largest gas companies, Wintershall and E.ON. This alliance between Russian and German energy giants has provoked consternation in Eastern Europe: In 2006, then Polish Defense Minister Radek Sikorski said the line revived memories of the Nazi-era Molotov-Ribbentrop Pact.

Russia is also planning a South Stream pipeline, which would make Russia largely independent of the Ukrainian transit route, allowing it to pressure Kiev at will -- as it did in 2006 and 2009 to undermine the pro-Western president Viktor Yushchenko. The line, which will run from Russia under the Black Sea to Bulgaria, partners Gazprom with Italy's ENI, Wintershall, and Électricité de France. The pipeline would also forestall attempts to bring Caspian and Middle Eastern gas into southeastern Europe, and prevent Turkmenistan, which sits on top of the world's fourth-largest gas reserves, from cutting out middleman Gazprom and selling directly to Europe.

But with estimated costs 50 percent higher than those of EU-backed rival Nabucco, the commercial rationale for South Stream is hazy. "Gazprom is what one would expect of a state-owned monopoly sitting atop huge wealth -- inefficient, politically driven and corrupt," was one U.S. diplomat's opinion, as revealed by WikiLeaks. That appears to be being borne out, as the company is increasingly burdened by subsidizing its domestic market and snapping up infrastructure to enhance political control in the post-Soviet "near abroad." As a result, there is a real risk that Gazprom may not be investing enough in the next generation of more costly, remote fields.

Europe needs to take decisive action. Its leaders should drop any illusions they may still entertain about the ruthless, cynical, calculating men in the Kremlin. It must deal with them from a position of unity and strength, not succumb to the temptation to strike side deals. If Germany shows impatience with eurozone fiscal indiscipline, it must demonstrate its own discipline, rather than self-indulgence, in the energy sphere.

The lesson of the decades since the first oil crisis is that, in the long run, energy exporters suffer more than their customers from embargoes and politicized manipulation. Russia's economy, founded on commodity exports, appears increasingly shaky -- and the vast costs of exporting Russian gas to China means the Kremlin has little choice but to look to Europe.

This realization should allow Brussels to aggressively challenge Vladimir Putin's government on human rights and geopolitical issues, as in the current stand off over Syria, and on the growing domestic opposition to Putinism. Europe's challenge is to reconcile its principles and its interest in promoting international free markets with a robust, activist energy strategy.

Europe's Kremlin-friendly gas oligopolies also need to be challenged by aggressive competitors. Liquid, flexible gas markets such as Britain's are gradually replacing the expensive oil-linked contracts that Gazprom insists are necessary for "supply security." Improved energy efficiency and better interconnections in Eastern Europe, particularly to Ukraine, would reduce Russia's ability to intimidate selected countries.

Alternative supplies should also be pursued more robustly. One of the EU's greatest energy security gains has come accidentally, via the great expansion of Qatari gas supplies. Qatar, which only began to export gas as recently as 1996, is now the world's third-biggest exporter and ships a quarter of the world's liquefied natural gas. There are good reasons for Qatar to challenge Russia for market share in Europe -- the disappearance of its planned U.S. market due to the boom in shale gas and its desire to restrain Asian supplies to maintain high prices there. Yet with Doha in talks with Moscow over joint Arctic projects, this favorable situation may not endure forever.

Europe's cooling relations with Turkey, marred by growing introspection and a touch of xenophobia, are also detrimental to the continent's energy security. Opposition to the Turks' EU bid has simmered over immigration, Islam, and human rights issues. But the willingness of some European politicians to cold-shoulder Turkey ignores its importance as a transit state for Caspian and Middle Eastern gas, as well as its leading role in Iraq, where resolving the endless tussles over the new hydrocarbon law and the disputes between the Kurdish authorities and Baghdad holds the key to allowing Iraqi gas to begin flowing north.

There are many other countries Europe can cultivate to secure its energy needs. If China can secure a gas pipeline from Turkmenistan, the EU should also be able to do so -- especially after Russia took advantage of a mysterious pipeline explosion, as demand slumped during the economic crisis, to cut its purchases from Ashgabat. Supporting the fledgling democracy in Libya, far from friendly to Russia, has the valuable side benefit of stabilizing an important potential secondary gas supplier. And Iran is a natural energy ally of the EU and a competitor with Russia -- but that realization awaits a Damascene conversion on both sides.

Finally, Europeans need to develop their indigenous gas resources, with proper environmental controls -- not fall prey to scare stories propounded by those with their own interests at heart. That is the best way to avoid freezing in the dark.