When Greece Defaults

The second European bailout of Greece will just delay the inevitable.

The second round bailout of Greek debt is just delaying the inevitable—Greece is going to default.

As details have emerged on the European Central Bank, European Financial Stability Facility, and International Monetary Fund joint agreement with private creditors and the Greek government on providing money to make sure Greece pays a March debt bill, it is increasingly clear that this deal will not be enough.

In broad strokes, the agreement will provide a EU130 billion ($172 billion) loan to Greece from Eurozone nations so it has cash to pay its pending debt bill and money to complete a bond swap with private creditors that will help reduce Greece's overall debt by EU107 billion.

In exchange the Greeks will have to fire another 15,000 public employees (on top of the 30,000 they were forced to lay off with the first bailout), cut their budget by another EU3.3 billion, and reduce the nation's minimum wage of EU750 a month by 22 percent for those over 25 years old, and by 32 percent for those 25 and under.

The target is to get Greek debt down to just 120.5 percent of GDP by 2020.

But a confidential 10-page report prepared for European finance ministers that was leaked on Monday suggests that the best-case scenario is closer to 130 percent of GDP by the end of the decade. Furthermore, the report suggested that if the bailout deal is not upheld on the Greek side, debt could rise to the 180 percent of debt-to-GDP range.

To put this in perspective, Greece should be at something more like 60 or 70 percent of debt to GDP to be a stable European nation.

The reality is that the first bailout provisions were not very closely followed. To say that 15,000 public employees will be fired is not to suggest they will be out on the street tomorrow. Rather a multi-year process is put in place to slowly work them off the public payroll. We've already seen a similar process done with the May 2010 bailout of Greece, where by late 2011 there were still no public sector workers who had been officially fired.

The second bailout is also based on overly rosy estimates of economic growth for Greece. Where the Greek economy has seen negative GDP growth of 7 percent recently and is projected to have no growth in 2012 or 2013, the target goal of 120.5 percent of GDP by 2020 assumes economic growth of 2.3 percent in 2014 and 2.0 percent in 2015.

But growth from where?

GDP growth of between 2 percent and 3 percent is about what the U.K. going to be able to muster in 2014. And since the Greek economy has little to build on, and much less substantial infrastructure, this economic target is beyond optimistic—it is ludicrous.

As Athens continues to burn and Greek citizens continue to reject austerity measures, the likelihood that the nation will stick with its pension reform, health care reform, and other budget reform promises is very low. The likelihood that economic growth will result in a debt-to-GDP measure of anywhere close to 120 percent is low. And the result of all this will be that Greece will again run out of money, be in need of a loan from its European brethren, and won't get it, forcing it to default.

As the leaked memo for European officials suggests:

The Greek authorities may not be able to deliver structural reforms and policy adjustments at the pace envisioned in the baseline… Greater wage flexibility may in practice be resisted by economic agents; product and service market liberalisation may continue to be plagued by strong opposition from vested interests; and business environment reforms may also remain bogged down in bureaucratic delays.

The frustrating part is that most analysts and finance ministers know this. They have the report. They can see the same numbers we do. But the unspoken thought is that the second Greek bailout simply represents all parties buying themselves more time.

The European governments want more time to get their fiscal houses in order before a Greek default trashes the value of the Euro. European banks want more time to prepare for the economic losses from a default. Italy, Portugal, and Spain want more time to see reform measures lower their debt levels. And collectively, the Eurozone wants more time to insulate itself from a Greek collapse and find a way to eventually push Greece out of the Euro and into the darkness as an IMF protectorate.

Although the bailout deal is political posturing and wishful thinking for anyone who believes this is the end of the story, it does serve as a helpful warning to Italy, Spain, and Portugal. Such sharp cuts in minimum wage, forced austerity, and the sense of a loss of democracy are not welcome pills to swallow—which is why riots continue in Greece even though there are few other options.

The Greeks would be much better off rejecting this deal and defaulting now. Another bailout might postone the inevitable until 2014 or 2016, but eventually, Greece is going to be unable to make its debt payments and there will be no European safety net. 

Anthony Randazzo is director of economic research for Reason Foundation.