The EUR/USD is the most generally traded currency pair, with 27% of trades in the forex market being made on this pair. Accordingly, the question of many traders right now is 'where is the euro headed?' and, 'what will happen when Greece defaults?'

The current situation

Greece's situation could be worse after strict austerity measures forced by the EU-IMF bailout, its economy shrank by 7.3% in Q2 of 2011, exceeding the most gloomy forecasts of both the EU and the IMF.

Meanwhile, Greek bond yields have risen to record levels, with on three-year-bond, which was trading at 20% in June, now trading at 172%. Bonds scheduled to be repaid in March 2012 are being priced at half their official price. And prices for Greek credit default swaps, which offer investors a defense against default, have more than doubled since the start of Aug, rising above 4,000 basis points.

Adding to the difficulty is the chance that Greece won't be given the next EUR8bn tranche of help, as German finance minister Wolfgang Schauble has accused them of not abiding by the terms of the aid agreement. This puts Greece in the tough position where excessive budget cuts mean it cannot boost its economy so it may grow its way out of debt, yet not effecting these measures means it does not have prepared money to pay state salaries and annuities in October.

Consequently, the question is not if, but when Greece will default.

What will happen when Greece defaults?

Once Greece defaults, the government will nationalise each bank in the country, and then forbid any withdrawals. To prevent riots among Greek depositors, the govt will then enforce a curfew, and could even declare martial law.

Greece will then leave the single currency and re-denominate its obligations into a new currency. Against the euro, this currency will devalue by around 50%, effectively defaulting on over fifty percent of all Greek euro-denominated liabilities.

Several French and German banks will make losses large enough to no longer satisfy capital adequacy requirements, while the European Central Bank will become insolvent due to its high exposure to both Greek administrative and Greek banking sector debt. The French and German administrations are then sure to meet to decide whether to recapitalise the ECB or to let it to print money to return to solvency. They will then recapitalise their own banks and likely refuse all future bailouts.

And this scenario doesn't consider the reaction of Ireland, Portugal, Spain and Italy the other struggling economies in the eurozone.

Nonetheless a Greek default might not be all bad. Of the countries that have defaulted in the last decade have not all performed as well since their defaults, the average post-default GDP rate of growth improved by about Three percent.

The fate of the euro

As far as the euro is concerned a default may be beneficial. As it would allow Greece to have a new, separate, currency that can be devalued, Greece is more likely to improve its competitiveness with favourable exchange rates. And, although there would be an instinctive sell-off of the euro and volatility over several months, the industrial performance of the eurozone as a whole would be boosted, particularly if it starts to expel the weaker members. This would end in a potentially powerful climb in the single currency.

Closing thoughts

At some stage, Greece will be forced to default, or leave the eurozone, if not both. The Greek economy has reached the point where it can't recover, and Germany's patience with the periphery nations and the European Central Bank is wearing thin. What remains to be seen is whether or not this will be an 'orderly' default, the voluntary debt exchange agreed in July where holders of Greek debt suffer 21% losses on bonds that mature before 2020, or a 'disorderly' default, where Greece walks away from its liabilities without consultation.