Greek banks and companies with obligations in euros, but revenues in drachma would default. Given the inter-relatedness of the global banking system, any bank with a whiff of Greek debt could soon find itself cut off from global credit creating a global credit freeze. In effect this would be like what happened after Lehman Brothers in 2008 – times 10 because such a crisis would hit at a time when the global economy and government balance sheets are very weak. Having thrown everything at the last crisis including the kitchen sink, there is little they could do! This credit freeze alone could push Portugal, Spain, Italy and Greece in default. Then again, a bank run in those countries as people remove their euros from banks to avoid the risk of a forced depreciation might very well tip those countries banks and hence the countries themselves into default first.

That is not to say that a Greek exit would inevitably lead to a global credit freeze and automatically domino to Portugal, Spain, Italy, etc. However, to prevent that from taking place the ECB would have to rapidly and decisively flood those markets with unlimited liquidity and provide blanket deposit insurance to forestall bank runs.

It’s also unclear a Greek exit would benefit Greeks in the long run. If it was accompanied by fundamental structural and tax reforms, the renewed competitiveness would put it on a sustainable growth path. However, given the current mood in Greece, the more likely outcome is for the benefits of the depreciation to be inflated away. After a few years of nominal GDP growth, Greece would find itself once again uncompetitive, but probably with a GDP that is 20% lower than it is today.

Worse, beyond the potential economic stagnation and meltdown that the world is facing because of the deleveraging process, the West is facing other large economic and non-economic challenges. The relative economic decline of the West in comparison to the growth in China is leading many people in the US and Western Europe to believe that the “Washington Consensus” should be replaced by the “Beijing Consensus.” I will discuss this in my next installment.