I like the way he puts it below:

“…if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Goodhart Says Greek Deal May Collapse as Crisis Tests Euro

By Svenja O’Donnell and Andrea Catherwood

May 4 (Bloomberg) — Greece’s bailout “might collapse” and the nation’s debt crisis makes it “hard to see” how the euro will survive in its current form, former Bank of England policy makerCharles Goodhart said.

“If this financing deal should collapse, and it might for one reason or another, then there would be a question of what the Greeks could possibly do,” Goodhart said in an interview with Bloomberg Television in London today. “Default would be totally disastrous for them and leaving the euro would equally be disastrous.”

Euro-region ministers on May 2 agreed to a 110 billion-euro ($145 billion) bailout with the International Monetary Fund to prevent a Greek default, after investor concern sparked a rout in Portuguese and Spanish bonds last week and sent stock markets tumbling. The Greek crisis shows the need for more integration within the euro as a common currency, Goodhart said.

“It’s very hard to see how this is going survive this particular test,” he said. “The euro system has either got to have much more integration or parts of it will fall by the wayside.”

Standard & Poor’s last week cut Greece’s credit rating to the junk level of BB+, lowered Spain’s grade by one level to AA and downgraded Portugal by two steps to A-. Greece has now agreed to budget-cutting measures worth 13 percent of gross domestic product.

‘Appalling Deflation’

“If the current bailout is put in place, it will be enough to meet their immediate financing problems not only this year but for the next year or two,” Goodhart said. “The problem is that it doesn’t meet their adjustment problems. It doesn’t deal with the problem the Greeks, in part from having too large a deficit and too large a debt ratio, are very uncompetitive and if they actually cut back the deficit as fast as is being required they’re just going to go into appalling deflation.”

Greek 10-year bonds yielded 8.7 percent, about 566 basis points more than German bunds, as of 11:32 a.m. in London. That spread is down from as high as 800 basis points last week, the biggest gap since the euro’s introduction 11 years ago.

Should the deal fail, Greece “might do a kind of dual currency in which they use their scarce euros to meet their external commitments and in the meantime use an internal IOU, rather as Californian and some of the Argentinian states did, in order to meet their internal commitments” Goodhart said. “It would be a dual currency and the internal currency would fluctuate compared to the euro.”

Such an exercise would be “very messy,’ he added.