The markets are off again today as the debt situation in Greece spins more out of control with every passing hour. The news from Athens is as grim as it can be despite the fact that some progress on the bailout was made last week. Presently, it appears that anything the euro zone comes up with will be too little and too late.

The Greek government has announced what everybody already knew—they will miss their deficit targets this year. The hope had been to get the deficit down to about 6.8% of GDP, but the reality is that the deficit will be close to 8.5% of GDP all while the economy as a whole is contracting by 5.5% as opposed to the 3.9% that had been predicted earlier. Greece has managed to enter a vicious cycle. The nations in the euro zone are demanding that Greece put its financial affairs in order with brutal austerity measures, but these moves only slow growth more.

In order for the country to get hold of its financial situation, it is being forced to engage in waves of austerity efforts, and this means cutting tens of thousands of people from the government payroll at the same time that tens of thousands of others are seeing their pay decrease radically. It is hard to argue that these are not necessary measures to some extent as even the most casual observer can see that Greece has a bloated public sector. This has to change, but the pace of this reform is extreme and hurling Greece deeper toward a downturn from which will be difficult to recover. The reaction from the population is predictable as well: rioting, protesting and striking.

Analysis: The most likely scenario here is as follows: The Andreas Papandreou government will accede to the demands of the Germans and the International Monetary Fund and agree to more draconian austerity measures. This will involve cutting deeply into the government and quasi –government jobs that make up the biggest part of the Greek budget.The public reaction to the mass job cuts will be overwhelming, and the Papandreou government  will likely lose many of its members. This will create a crisis in the government, as the Socialists lose their ability to control the parliament without the opposition being in a position to take over. The resulting civil unrest will be beyond the ability of the police to control, and the military will be called upon to engage. The entire nation could essentially shutdown until something radical takes place. The most pessimistic assessment of this situation ends with the military taking control of the system in some kind of martial law action.

The only way all of this is averted is if the nations demanding Greek compliance with radical austerity relent and decide that reform in Greece is going to have to take far longer than they would prefer. As logical as that position may be, there is a steep political price to pay for such a move, and it is not at all certain that the leaders of the north will be willing to pay it.

Source: NACM Economist Chris Kuehl