Go ahead and default, Greece!

greece_default.gi.top.jpg by Dody Tsiantar, contributor


(Fortune) -- Greece must be feeling a little like Sisyphus these days. Saddled with mountains of debt and a 14% budget deficit, its path to recovery seems arduously steep, slippery and out of reach. But like Sisyphus, the king in Greek mythology who ends up getting to the summit only to see his cumbersome load slide back down again, Greece seems mired in problems even with a $145 billion bailout package.

Despite initial market giddiness over the bailout and displays of confidence from the IMF and Greek government officials that Greece, albeit bloodied, will manage the painful journey back to economic health just fine, fears that the country won't be able to push the boulder back up the hill are back with a vengeance.

The key concern: the measures Greece has been forced to impose are so severe and wildly unpopular that observers fret the government won't have the political will to see them through. Economists also worry that the very medicine prescribed by the IMF and Greece's Euro-partners -deep budget cuts, sharp wage reductions and tax increases- will push the economy into a recessionary spiral that will spin downward faster than Sisyphus' lost boulder.

Walking away

So what's in store for the Greeks? If the loan conditions will bring in as much agony as is predicted, why not walk away from their obligations-the same way so many thousands of debt-saddled Americans have-instead of taking on even more debt to pay them off?

Of course, it's not that simple. Americans who don't pay up end up with bad credit. And when a company goes bankrupt, it risks having to shut down forever. But what happens when a country defaults? Obviously, Greece won't melt away into the Aegean Sea. The Parthenon won't vanish.

"A company can go bankrupt. Individuals go bankrupt. But sovereigns don't," explains Jan Randolph, head of the sovereign risk group at IHS Global Insight. "They stop paying and don't service their debt obligations like they're supposed to. But people still grow carrots, people go to school, traffic lights work."

That doesn't sound so bad, but don't be fooled. A 2008 IMF working paper, titled "The Costs of Sovereign Default," found that post-default, most economies, on average, tend to shrink by 1.2 percentage points a year during restructuring. Often, more severe political, social and financial consequences follow.

Take Argentina, which defaulted in December 2001 after struggling with IMF-imposed austerity measures for several years. Unemployment hit 20%, GDP declined by 15% and nearly half its population ended up living below the poverty line.

To boot, the Argentines have been locked out of financial markets and the government has been embroiled in hundreds of investor lawsuits ever since. (Read more about the impact of Argentina's default.) For nine years, Argentina has been deprived of the "oxygen credit markets can provide," as IHS's Randolph puts it, and is only starting to tip-toe back in now with a debt swap offering.

But is a default, or a partial one, always as deadly a sentence as we've been led to believe? Not exactly.

"There are defaults and there are defaults," says University of Maryland international economics professor Carmen Reinhart, who co-wrote the recent book, This Time is Different, an analysis of eight centuries of financial crises.

According to Reinhart, defaults are more common than we think. But some defaults are ugly and messy like Argentina's, she explains, and others are kinder and gentler, like Uruguay's, which came to a cordial agreement with its creditors to restructure its debt in 2003 and recovered quickly, growing nearly 4% the following year.

Turning it around

But defaults, even ugly ones, don't always spell disaster either. After its debt debacle, and the eventual devaluation of the peso, which made its agricultural exports cheaper, Argentina recovered too, growing 9% in 2004. Despite the years of negative publicity, it also became a tourist hotspot-the cheap cost of living and a favorable exchange rate made it a favorite for American tourists and it experienced double-digit increases in incoming visitors. After Russia defaulted on its foreign debt in 1998 and devalued the ruble, it grew 6.4% a year later.

For Greece to pull off a default-driven revival, it will have to be ready to anger a lot of folks, most importantly its bondholders. The country could also be forced to abandon the euro and return to the to the drachma, or some version of it. The fireworks over Europe, should Greece go that route, would be something to see.

But the gain may be worth the pain. University of Maryland economics professor Theodore Kariotis points out that dropping the euro would put monetary policy muscle, control and flexibility back into the hands of the Greek government. It might even help Greece keep Sisyphus' boulder at the top of the hill where it belongs. To top of page