08 Dec Der Spiegel on the Possibility of a Greek Sovereign Bankruptcy
Der Spiegel has an excellent story on the possibility that a Eurozone country might default on its sovereign debt, with economic, political, and legal consequences that could be anything from serious to dire. The country is Greece:
Greece has already accumulated a mountain of debt that will be difficult if not impossible to pay off. The government has borrowed more than 110 percent of the country’s economic output over the years, and if investors lose confidence in the bonds, a meltdown could happen as early as next year.
That’s when the government borrowers in Athens will be required to refinance €25 billion worth of debt — that is, repay what they owe using funds borrowed from the financial markets. But if no buyers can be found for its securities, Greece will have no choice but to declare insolvency — just as Mexico, Ecuador, Russia and Argentina have done in past decades.
This puts Brussels in a predicament. European Union rules preclude the 27-member bloc from lending money to member states to plug holes in their budgets or bridge deficits.
And even if there were a way to circumvent this prohibition, the consequences could be disastrous. The lack of concern over budget discipline in countries like Spain, Italy and Ireland would spread like wildfire across the entire continent. The message would be clear: Why save, if others will eventually foot the bill?
On the other hand, if Brussels left the Greeks to their own devices, the consequences would also be dire. Confidence in the euro would be shattered, and the union would face a crucial test. What good is a common currency, many would ask, if some of the member states pay their debts while others do not?
Furthermore, there is a threat of a domino effect. If one euro member falls, speculators will test the stability of other potential bankruptcy candidates. This could destroy the currency union. Because of this systemic risk, say the economists at the Swiss bank UBS, “we believe that if a country is facing a problem with debt repayment or issuance, it will be supported.
A default of a euro-group country doesn’t worry the monetary policy hawks at the Bundesbank, Germany’s central bank. “So what if Greece stops paying its debts?” one of the executive board members asked at a recent banquet in Frankfurt. “The euro is strong enough to take it.” The real threat, he says, is if Brussels comes to the Greeks’ aid. “Then the currency union will turn into an inflation union.”
This article has circulated widely in the economic policy blogosphere. Megan McArdle has an excellent discussion of the broader questions about the Euro, going back to her days at the Economist:
The euro zone, on the other hand, has tightfisted Germany spliced together with spendthrift Italy, which previously relied on serial devaluations of its currency to boost exports and ease the burden of its debt payments. This is why I was more skeptical than most observers–including most of my colleagues–that the euro zone was going to survive long term. If a few members are forced to exit, either because the central bank’s monetary policy is keeping them mired in recession, or because they need to inflate away a massive debt burden, then it’s hard to see how the zone survives. If investors think the euro zone is fragile, they’ll demand higher interest rates to compensate for the currency risk they’re assuming. Furthermore, a smaller currency zone means smaller gains from trade, and presumably less incentive to pay the price of turning your monetary policy over to the ECB.
So far I’ve been proven wrong. But Greece’s situation may provide an unhappy test of my hypothesis. There seems to be some serious moral hazard in the market for the debt of troubled euro zone members: as the quote above implies, investors are betting that other members will bail Greece out rather than risk damaging the euro. As we saw right here in America, markets that believe in implicit government debt guarantees are extraordinarily fragile. And as we saw in America, there may be no good solution: bailing out Bear and letting Lehman fail were both extraordinarily costly.
A Greek bankruptcy thus has serious implications for Europe, and indirectly, for the rest of us. European banks are heavily invested in Greek bonds, and if the country defaults, it’s probable that speculators will start eying other euro zone members.
But I wonder what, if any, are the questions for public international law, or public transnational law, or the constitutional order of the EU? Does a Greek bankruptcy raise any issues for the political order of the EU? Or can currency arrangements be kept separate from the EU, in the way that, for example, the UK stays out of currency union? (I would point, by the way, to the work of my colleague Anna Gelpern, who is one of the leading scholars on sovereign debt restructuring – one of these days next semester, I’ll ask her to give us a guest post on what she thinks might transpire with Greece and other troubled small EU economies.)