Why can't it happen? It's happening already in Greece. Greece will have to default on their debt any day now. What happens in the next round of the financial crisis? The problem wasn't fixed in 2008, merely delayed and exacerbated. Who's going to bail them out, this time? The Governments are out of money.

Greece seems to be willing to defer it, as their upcoming plebiscite indicates. They will likely reject any punitive solution, and this is a forewarning against other attempts to institute austerity.

I think that's his point.  If they reject the austerity they will more or less immediatly defualt on their debt as they NEED austerity to survive.

Auesterity is coming either way pretty quickly.

Yes, but if democracy defies austerity to the utmost, who can win? The banana republics of yore simply defied their debt, like Venezuela, Haiti, and the Dominican Republic

Nobody wins, and Greece loses harder, if they try and defy their debt, they'll be kicked out of the euro, cut out of the eurozone, debts will skyrocket even higher and people will just refuse to deal with Greece.

The bannanna republics didn't really benefit with trade.

While Greece greatly depends on it...

Only way Greece could work like a Bannana Republic is if Greece's plan is to make the Europeon Austerity measures look like paradise compaired to what they would get by voting down the austerity measures.

Before we start, I'd just like to say that I had never heard the term "defied debt" until this point. A quick Google search actually did nothing, so I'm just assuming that you mean that they refuse to pay the debt (as I know this is what Venezuela did, and that was one of your examples).

First and foremost, I'm talking about how the soverign debt crisis can lead to a financial system collapse. If Greece defies their debt, the banks who lent out that money will be put into the same financial crisis. The ONLY way a financial crisis will not occur is simply if Greece makes those payments. They cannot do this, so all other routes lead to a financial crisis.

Second, democracy cannot defy austerity. At most, democracy can only lead to sustained deficits. The problem arises with funding these deficits. If Greece cannot borrow the money (which they pretty much can't, and certainly won't be able to if they default/refuse payment), the only means of funding the deficits is through printing money. This cannot be done while Greece is a part of the Eurozone. If Greece took the route of claiming back their own currency, for the simply means of just being able to fund deficits, the currency wouldn't be worth the paper it was printed on, hyper-inflation would set in, and austerity would be forced on the Greeks, that way.

You cannot create wealth from nothing. Any form of deficit spending is merely taking wealth away from the future. When you cannot borrow, it literally becomes physically impossible to run a deficit (any gains made by printing the money to fund the deficit, will be lost in inflation).

I meant it in the context of democratic institutions refusing to impose austerity due to the will of their constituents. I mean, who the hell will take on a platform of "Fewer benefits and higher taxes?"

Papandreu himself seems to have been taken down within his own party under the very idea that he would cooperate with this.

I'm well aware of the economic consequences of this, i'm just saying that they would have to come about if the people will against it, but so much of our modern economy is founded on pure willpower (Confidence itself is the most significant asset, and a lack thereof more damning than any debt) that i imagine a system of wilfully defied debt could work out if everyone agreed to it. Total revolution is also a way to go debt free, since i can't imagine any foreign banks that bought War Bonds off of the Tsar ever saw any of that money, nor American banks who may have lent to the Shah.

My point was rather a missive against democratic institutions and their inability to act responsibly when given direct control over matters of foreign affairs such as this

Yes, but, even in these scenarios, there will be a financial system collapse (which is the point of this discussion). If the banks do not get their money back from Greece, no matter how this happens - be it default, defiance, revolution, then there will be a second credit crunch. With the key difference between the last credit crunch, and the one we're talking about here, is that there's no one left to bail out the banks.

No matter what path Greece takes, now, they will be subject to a lower quality of life. If they default, I've seen reports that they could see their economy decline by up to half, if they defy, they will be subject to hyper-inflation, if there's some kind of revolution... then they will get out of some problems, but will still be facing a world going through a second, and more severe, credit crunch - and after the crunch, they'll still be seen as an extremely high-risk country to lend to ("hey, they're the country that would rather revolt than face higher taxes to pay what they owe").

I don't think it is a problem of democracy. Afterall, Switzerland is a democracy, and they seem to have maintained very sane economic policies over the past few years. I think the real problem is that too many politicians subscribed to keynsian economics, and they sold their constituents keynsian economics. I do think we have a problem in the EU, with leaders putting their pro-EU political ideologies ahead of rational economic thought, but that's not a problem of democracy, just one of the EU. We'll see how the Ron Paul candidcy goes, before I denounce democracy on the whole. :P

I would like to point to Ireland, actually, who seem to have done exceptionally well, seeing as they were one of the first countries that had a debt crisis. They took austerity seriously, and the effects on the economy have not been as bad as what many people would have believed. For one thing, Ireland was the only Eurozone country that saw its PMI positive last month. A lot could be learned from the way Ireland handled itself in the debt crisis.

As an aside ...

I believe the Greek referendum is DOA. Austerity is unpopular and would be voted down in a referendum but, while Greece's PM will eventually lose a non-confidence vote and then the following election, most opposition MPs know it is necessary and will be easier with the aid of other European nations; and they won't bring down the government until after the austerity measures are implemented so that George Papandreou can be the "fall guy".

Yeah, it seems that the Greek Government are pulling away from the idea of a referendum.

http://www.marketwatch.com/story/greek-officials-disagree-over-referendum-2011-11-03