Monday, 17 January 2011

Eurozone debt restructuring: What is to be done?

The Eurozone periphery - Greece, Ireland, Portugal, Spain, Italy and Belgium - are tottering on the brink. Their governments have accumulated too much debt, and their capacity to repay these debts is in doubt.

What is to be done? There are two options; fiscal austerity and debt restructuring. The first requires deep cuts in expenditures, and higher taxes. The hope is that this strategy will cut the fiscal deficit, and gradually lead to a reduction in public sector debt levels.  Lower public debt might also reduce long term interest rates and help sustain economic growth.

The second is a debt default. Governments would no longer repay the full value of the contracted debt. The burden of adjustment will fall on creditors and not on the general public. Painful austerity would be avoided. Governments would not have to explain to their electorates why taxes have gone up and social services have deteriorated. However, public sector creditworthiness would suffer, which would lead to higher long term interest rates and possibly lower growth.

Here are four perspectives on the debate. First up, John Makin, who suggests that the Eurozone economies are in an untenable position, where further austerity efforts only serve to increase debt levels.

"There are several insolvent countries along Europe's periphery. Their debt levels are unsustainable in a specific sense. Attempts to reduce their debt-to-GDP ratios by cutting deficits actually have increased the ratio of debt to GDP by slowing growth for countries with an already high—over 100 percent—debt to gdp ratio."

Laurence Kotlikoff thinks default is the lesser of two evils:

"I think each of the PIIGS should do a careful fiscal gap analysis to understand if the present value of their projected spending can be covered by the present value of their projected taxes assuming normal borrowing rates. If the answer is no and the required fiscal adjustments are far beyond what can be achieved, then restructuring the debt is inevitable. And doing so sooner rather than later makes sense. Paying creditors, say, 50 cents on the euro may suffice, but it will come at a real cost in terms of higher borrowing rates for decades to come."

Harold James casts the issue in moral terms:

"The principle of not reneging on public debt is deeply intertwined with the development of legal security, representative government, and modern democracy. The experience of wartime inflations and de facto defaults in the 20th century made the theme of responsible finance a crucial part of a new European consensus. A foundation of the European integration process was a recognition of the importance of a stable currency to political legitimacy."

Paul Seabright argues that the Eurozone periphery are too deep in debt for moral considerations to play any part in the debate:

"It has long been evident that, barring a miracle economic recovery, some countries in the euro zone were going to default on some part of their sovereign debt. It has also long been evident that an orderly debt restructuring would be vastly preferable to a disorderly default triggered by a market panic. Unfortunately politicians have perceived their interests as lying in the perpetuation of the belief that restructuring could be postponed, and indeed had to be postponed at all costs because it would threaten the very existence of the euro."

Neither option looks terribly appealing.


LEA said...

The UK is going for option 1. Sooner or later (probably sooner) the PIIGS will have to choose. Option 2 looks better for them.

JohnofEnfield said...

Iceland chose to default.
It has worked.

None of the PIGS are strong enough in terms of fiscal discipline to take any other alternative. Greece has done a lot but is still not cutting its budget anywhere near enough. The same is true of Eire.

All the PIGS need to default at some time - it is better that they do it sooner rather than later.

You try all you like but none of the alternatives are workable.

WF said...

Fifty years of fiscal extravagance - it comes down to this stark choice.

Anonymous said...


Actually the jury is out on Iceland's default. The news stories telling of growth did not tell of the dark side. Read the comments below this article.

I agree that the banks should have been allowed to fold in the UK, but we are where we are. It is the state guarantee of liabilities other than deposits which was wrong. In a free market you must allow failure of businesses.

Anonymous said...

Dear Clouded Outlook

Debasement of the currency - otherwise known as inflation - is slow motion default in small easy steps.

It requires a national currency to work.

The PIGS, now PIGIS, soon to be PIGIBS, share one currency between them with other countries which have yet to join the default club. They cannot set the rate of default by debasement; it is set elsewhere and at a rate which is not tailored to the several economies wishing to default by degrees.

Our default-in-nice-easy-stages (currently around 4.7% pa) is well within the superinflation range as defined by me. Hyperinflation starts around 10-12.5% to follow the aeronautical definition of hypersonic equals five times the speed of sound (superinflation starts at 2-2.5% pa, thus hyperinflation is 10-12.5% pa. Simples.)

Iceland did not default. Icelandic banks did. There is a world of difference.

Why our government chose to wipe some of our (mostly Scottish) banks’ financials with our money is for us to ponder.


Alice Cook said...


Absolutely - inflation is a default. It is not an option available to the Eurozone periphery.


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