This is what the Greek default looks like

Europe will have to make its choice this year. Either a much tighter, more constrictive fiscal union with a central bank that can aggressively print euros in this crisis, or a break-up, either controlled or not. I don’t think they can kick the can until 2013, as the market will not allow it. Either the ECB takes off its gloves and gets down to real monetization when Italy and Spain need it, or the wheels come off.

If you want to understand what’s going on in global financial markets, go to John Mauldin’s site and subscribe to his free weekly newsletter Thoughts from the Frontline. Every week he pores over analyst reports, travels, talks to a lot of people who know what’s going on behind the scenes, and sits down to package thoughts, numbers and charts to be conveniently delivered to your inbox to provide you with food for thought.  Also from this week’s newsletter: this is what the Greek default looks like.

Greece has two choices. They can choose Disaster A, which is to stay in the euro, cutting spending and raising taxes so they can qualify for yet another bailout; negotiating more defaults; getting further behind on their balance of payments; and suffering along with a lack of medicine, energy, and other goods they need. They will be mired in a depression for a generation. Demonstrations will get ever larger and uglier, as the government has to make even more cuts to deal with decreasing revenues, as 2.5% of their GDP in euros leaves the country each month. There is a run on their banks. Any Greek who can is getting his money out.

Greek voters will then blame whichever political group was responsible for choosing Disaster A and vote them out, as the opposition calls for Greece to exit the euro. Which is of course Disaster B.

Leaving the euro is a nightmare of biblical proportions, equivalent to about 7 of the 10 plagues that visited Egypt. First there is a banking holiday, then all accounts are converted to drachmas and all pensions and government pay is now in drachmas. What about private contracts made in euros with non-Greek businesses? And it is one thing to convert all the electronic money and cash in the banks; but how do you get Greeks to turn in their euros for drachmas, when they can cross the border and buy goods at lower prices, as inflation and/or outright devaluation will follow any change of currency. It has to. That is the whole point.

So how do you get Zorba and Deimos to willingly turn in their remaining cash euros? You can close the borders, but that creates a black market for euros – and the Greeks have been smuggling through their hills for centuries. And how do you close the fishing villages, where their cousin from Italy meets them in the Mediterranean for a little currency exchange? What about non-Greek businesses that built apartments or condos and sold them? They now get paid in depreciating drachmas, while having to cover their euro costs back home? Not to mention, how do you get “hard” currency to buy medicine, energy, food, military supplies, etc.? The list goes on and on. It is a lawyer’s dream.

There is a third choice, Disaster C, which is worse than both of the above. Greece can stay in the euro and default on all debt, which cuts them off completely from the bond market for some time to come. This forces them to make drastic cuts in all government services and payments (salaries, pensions etc.), and suffer a capital D Depression, as they must balance their trade payments overnight, or do without. Then they choose Disaster B anyway.

Very much the same could be said about Italy, II: Troubles in Greece

As unique as my country is, I often read about other places that are similarly stuck in the holes they’ve been digging for themselves. But in the United States, the Obama administration has already announced that they mean business when they talk about upgrading the country’s creaking infrastructure, promoting clean energy, and fixing health care (see my previous post quoting Fred Wilson). We haven’t done that – so, the parallel no longer applies.

Today, instead, the Friends of Italy Award of the day goes therefore to Greece, described in today’s Economist in the following terms.

[…] Far more important are problems that no Greek government has tackled. To find out what they are, ask any of the Greek-born scholars, entrepreneurs, artists and other talented types who flourish all over the world but recoil at working in their homeland, much as they love it.

As any homesick Hellene can tell you, their country can be a maddening place for people with drive and flair. The world’s universities are full of Greek academics, but the country’s own campuses are dogged by poor administration, strikes and a state monopoly on higher education. In its university system Greece hews closer to the worst aspects of the Ottoman past (such as bureaucracies that block innovation) than does Turkey, with its fine range of public and private campuses.

In health, schooling and other public services, bad state provision fuels a huge under-the-counter market—creating in turn vested interests opposed to any change. Life is tough for youngsters with energy and talent but no cash or connections. To get anywhere, they spend all day in rotten state classrooms, then trek off to private night schools where the same teachers do a slightly better job in return for money. Anybody who negotiates those hurdles must then face a dismal job market—either a dreary, dysfunctional public sector or a private sector crimped by crooked tax inspectors and crazed regulators.