The good news is that countries have defaulted before. Since the 1500s up until now, Spain has defaulted 13 times. Following World War II, a total of 17 countries defaulted on over $10bn in debt to the U.S. Sovereign nations defaulting on their debt is nothing new. In fact, Kenneth Rogoff, the leading expert on sovereign debt and professor of Economics at Harvard, describes sovereign default as a sort of “rite of passage” for emerging nations. Let’s not forget that U.S. municipalities have had their fair share of defaults including most notably Detroit, San Bernardino, and Stockton and while several well-known Wall-Street analysts predicted disaster, as Detroit was defaulting in 2013, the S&P rose over 20%.
The bad news is that a nation has never defaulted as part of a large currency or a monetary union before. Consider an individual who earns $4,000 a month, but spends $6,000 a month and over time wracks up a considerably large credit card bill. Not only does that person need to cut $2,000 out of their budget just to balance the budget, but they must also cut into their budget even further to pay off the credit card debt. This is Greek’s situation. They have spent beyond their means for so long that not only do they not know how to live within their means any longer, they also have amassed a giant debt that they don’t seem to be able to pay back. Fortunately, when you consider the way the credit system works, when one person defaults on their credit card debt, it doesn’t bring the whole system crashing to its knees because there are enough other individuals who are making responsible decisions and paying off their debts on time. This is the current situation and the question now facing Europe. If one country defaults are the rest of the countries strong enough to keep the union together and the answer is likely yes. There will be pain to spread around with Greece bearing the brunt of it, but Europe will most likely live to see another day.
While a Greek default and possible exit from the European Union shouldn’t mean the end of the world, the market may still sell off if a default does happen. This has less to do with the economics of default and more to do with the economics of behavior and the ongoing game of hot potato that investors are playing. No one wants to be the last person to sell if the market takes a dip and given the fact that the market has only gone up the last five years, a dip may well be on the horizon simply because people are looking for it. The relevant question then becomes, how prepared are you to weather a dip in the market? If you need money in the short term, for example to purchase a new home, you may want to consider transitioning a portion of your investments to a more conservative strategy. If, however, you have no immediate needs and are investing your money for the long term, then consider a dip as an opportunity to test your ability to weather the course and potentially even buy in to capture the upside.
Reinhart, C. M., and Rogoff, K.S. (2008). This Time Is Different: A Panoramic View of Eight Centuries of Financial Distress. National Bureau of Economic Research. Retrieved from: http://www.nber.org/papers/w13882.pdf.
Reinhart, C. M., and Rogoff, K.S. (2013). Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten. International Monetary Fund. Retrieved from: https://www.imf.org/external/pubs/ft/wp/2013/wp13266.pdf