Opinion

Felix Salmon

Why European debt defaults are necessary

By Felix Salmon
November 30, 2010

Jim O’Neill of Goldman Sachs is now going around saying that the eurozone needs “solidarity,” and that Germany in particular needs to get with the all-for-one-and-one-for-all program, after getting itself into this mess by encouraging far too many countries to join the euro in the first place. At the same time, the survival of the euro, he says, “requires Germany to be not so noisy and aggressive about how other countries should run their economies.”

You can see the problem here: if enacted, it would mean that the European periphery can run up massive debts, safe in the knowledge that Germany will pay them off. Willem Buiter calls this by its proper name—permanent fiscal transfer—and says that it’s “most unlikely” even in Ireland, let alone in (say) Greece.

Even Buiter—who now works for Citigroup, remember, which has a long and painful institutional memory when it comes to sovereign lending—is talking about the fact that some kind of default (he calls it “restructuring”) will be necessary, certainly in Greece and Ireland, before markets have any confidence that the problems in those countries are resolved.

Certainly the current pain in Greece—retail sales down 10% year-on-year—feels very similar to the deflationary nightmare that Argentina lived through pre-default. The post-default chaos was worse, but the fact is that default was needed, in Argentina, to get the country back onto a growth path. And Argentina’s debt levels were much lower than those in the European periphery.

Europe is going through a debt crisis, and a debt crisis can only be permanently resolved by reducing—rather than simply rolling over—the debt in question. Sovereign debt crises are special cases, and in some rare cases—Brazil in 2002, say—they can be resolved through fiscal policy and economic growth rather than through default. But Greece 2010 is not Brazil 2002. It has vastly more debt, for starters, it doesn’t have a free-floating currency, it doesn’t have oil and other natural resources like soybeans and iron ore which bring in enormous income during a commodity bubble, and more generally it doesn’t have the ability to grow quickly for a sustained period of time.

The EU in general and the European Financial Stability Facility in particular have bought Europe’s periphery some breathing room. They need to take the next couple of years to work out an equitable and workable debt restructuring in these countries. Without one, they will be mired in deflationary recession, exacerbated by massive fiscal cutbacks, for years to come.

Comments
9 comments so far | RSS Comments RSS

“And Argentina’s debt levels were much lower than those in the European periphery.”
Only at the official 1 for 1 peso/dollar rate, much worse at the devaluation rate.

Posted by alea | Report as abusive
 

print money.

both ‘restructuring’ and printing money imposes real losses on savers/lenders, but printing money leaves nominal contracts intact, leaves nominal assets > nominal liabilities etc. and results in a whole lot less turmoil.

The downside of course is that it imposes losses on savers who did not chase yield and are now bleating because default risk has come back to bite them. Shame.

Posted by Luis_Enrique | Report as abusive
 

I think that the world got sucked into money government and forgot that governments are supposed to be for keeping the country pointed in the right direction. The siren song of money caught the world governments and the banks unknowingly went along. Now we don’t know right from wrong and our financial system is shot to hell too.

Posted by fred5407 | Report as abusive
 

Doesn’t some of the panic here stem from investors destabilizing the soveriegn debt by refusing to snap up debt at market levels and only buying this debt at higher and higher rates resulting in interest payments that governments can’t sustain?

I mean I acknowledge that the root of the problem is poorly managed governments. (See US for example)

The point of this article is to force the investors to bear consequences to their risk.

I would suggest another alternative that the Fed is doing now for US debt issuance. The ECB could basically support bond issuance by stepping in and buying bonds at some predetermined rate. Say 5%. Perhaps they end up buying all the bonds. But the “pirates” that are currently swooping in to get high rates on bonds they know are essentially backed by the ECB will have to settle for sub-5% returns or walk away from the investment.

This plan wouldn’t solve anything. But it would give Europe (and everyone else) some breathing room and could quarantine the contagion of crises.

Posted by ElroyFromIowa | Report as abusive
 

Germany WILL NOT INFLATE. And anyway there is no ‘real’ difference between rolling over debt, and transfering the liabilities to future taxpayers or future economic drag caused by inflation.

Debt restructureing must mean that someone takes the loss of real fruits of their labor money.

Anything else is a form of ‘debt rollover’.

Posted by tonydd | Report as abusive
 

Felix, look into who owns those Irish and Greek bonds. Outside of the Euro-zone, minority ownership. Inside the Euro-zone, not so happy. A Greek default in particular nails French banks, which is why Sarkozy is so for the German’s taking a hit. The way he stuck it to the Germans is masterful, in a Tallyrandish amoral sort of way. Either way, the pain is going to be spread around Europe.

Posted by ARJTurgot2 | Report as abusive
 

In the post above on QE2, Felix talks about the second order effects. There are second order effects of European debt defaults as well. Similar to Lehman, we don’t know what the second order effects are until it’s too late. With Lehman, it was the seizing up of the debt markets, commercial paper, money market funds etc. which mandated TARP and all the other bailout funds.

Just today, Assicurazione Generali’s CDS have blown out, as it came to light that their investment portfolio is loaded with european sovereign debt. Sov debt defaults would cause Ass Gen to go under, thus causing stress among all their insureds as well as debt holders. And on and on.

We say “debt default” is the answer to the problem every time, and then when we let it happen, and the financial world spins off its axis, we remember why debt default isn’t such a good idea.

Posted by Bernanke | Report as abusive
 

Do you remember old adagyum: homo homini lupus, means human is ones fox for the others ?
this is the old economic system of capitalist which borne collonialism we have burried some decades ago, but now tend to wake up again.
The fall of communist economic system in Rusia caus by its own people without out side intervention, which can not stand the sistem that wealth hold by the state and not distribute to full fill their people needs.
The capitalist economic system is shacking now all over the world lead by occupy wall street and now spread over all capitalist system. the contagion already in Germany. So how could you ask germany to shoulder the fall of the system. if I am a german people i would say save germany first. greek have to save by the greek. How could others help greek when their people not willing to safe their own country?
The furry of Euro and occupy wall street can only resolved by new and justice economic system.
Lets forget the “LUPUS ECONOMIC SYSTEM”,and find a more human and justice system.

Posted by OKTA | Report as abusive
 

Do you remember old adagyum: homo homini lupus, means human is ones fox for the others ?
this is the old economic system of capitalist which borne collonialism we have burried some decades ago, but now tend to wake up again.
The fall of communist economic system in Rusia caus by its own people without out side intervention, which can not stand the sistem that wealth hold by the state and not distribute to full fill their people needs.
The capitalist economic system is shacking now all over the world lead by occupy wall street and now spread over all capitalist system. the contagion already in Germany. So how could you ask germany to shoulder the fall of the system. if I am a german people i would say save germany first. greek have to save by the greek. How could others help greek when their people not willing to safe their own country?
The furry of Euro and occupy wall street can only resolved by new and justice economic system.
Lets forget the “LUPUS ECONOMIC SYSTEM”,and find a more human and justice system.

Posted by OKTA | Report as abusive
 

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