Guessing game on Grexit

Not many people can predict correctly the movement of the stock market; there are plenty of people who can give explanations for a rise or fall in the index after it has happened.

The same is true, I guess, of major macroeconomic events. I have been following the twists and turns of the negotiations between the newly elected left-wing government in Greece and the triad of the EU, the ECB and the IMF. I do not have answers to three questions:

i. Will Greece default on its debt?

ii. Would such a default lead to a Greek exit or Grexit?

iii. Will a Grexit seriously impact the world economy.

The best guess I have is that the impact of a Grexit on the world economy will be greater than the European authorities think. I believe that is also the serious apprehension the Americans have, as this article in FT makes clear. The Americans should know. They didn't think the collapse of Lehman Brothers would lead a to crisis; it lead, we know, to a catastrophe. So when the president of the ECB claims that Europe has the tools to handle the fallout of a Grexit, there's reason to be sceptical.

As Martin Wolf points out in another article in the FT, the Greeks have made substantial adjustments in terms of the primary deficit, the fiscal deficit and the current account balance. There have been enormous costs in terms of reduced output and employment. Any further "reforms" must carry with them, not just the promise of the release of bail-out funds already promised by a substantial debt write-off. Very simply, any further sacrifice on the part of the Greeks must carry a substantial reward. Only such a deal can be sold to the people of Greece.

The Europeans think they can handle a Grexit. What if Greece itself is able to handle it? Will that nor provide clear incentives to Spain, Portugal and others? Will not the electorates in those countries want to do likewise?

It would be foolish to under-estimate the long-term impact on the world economy of Grexit.