A default on sovereign debt within the Eurozone is widely considered to be the first domino of a violent chain reaction that would send a shockwave through the European banking system, triggering other sovereign defaults, a spate of financial sector nationalisation, and another world recession. It is seen as a cataclysmic event that must be avoided at all costs.
However, the public have long ago woken up to the fact that these costs are to be borne not by those who made the foolish decisions to lend money to the untrustworthy governments and failing banks, as you would expect in a capitalist society, but instead by the hardworking majority, who are to be saddled with even more debt, taxes and decreased public services in order to prevent the default from ever happening.
Yes the politicians and corporations do run the show, but for those of us still privileged to live in a functioning democracy, our majority should be our saving grace. Peoples of Europe unite, and embrace default!
* * *
Politicians do not relent in reminding us that default is not in the interests of anyone. They say that the economies of Europe are more interlinked than ever, and if one of them caves, the whole edifice will collapse like a house of cards. A sovereign default would undoubtedly cause widespread destruction - Nomura Securities estimated that the restructuring of Greek, Irish and Portuguese debt alone would result in direct and indirect losses of $240 billion for Eurozone banks – but it is increasingly becoming evident, particularly for the heavily indebted ‘bailed-out’ countries, that the pain of default is best swallowed as soon as possible.
1) The survival of the Euro has nothing to do with the solvency of the member states:
The risks posed by sovereign insolvency are economic. If a country defaults, its creditors will not get paid, and its credit rating will plummet. It does not impose some kind of danger on the existence of its currency. If Scotland were to go bankrupt and refuse to pay its creditors, there would be lots of angry banks and business owners, lots of people would lose money, and no one would want to lend money to Scotland ever again, or at least for a long long time. The Pound Sterling, however, would still exist. To say that a Greek default risks the survival of the Euro is nonsense. The only risks to the survival of a currency are its over-issuance by its producer (the central bank) or a voluntary switch to a different currency. A government that insists on propping up its banks and bond investors “at all costs” is much more of a threat to the currency’s survival than an honest government that admits when it is insolvent and pays the price.
2) The Eurozone crisis is only one element of the overarching crisis facing the entire developed world: the debt crisis, and under the current political framework, we will all have to pay for the profligacy of the few:
The current crisis faced by the developed world is a debt crisis. In other words, there is too much debt. There is too much public debt, too much corporate debt and too much personal debt. There is too much debt. There are more claims on wealth than there is wealth. For too long we have been exporting paper IOUs in return for real wealth, and now that those IOUs are being called in, our standards of living will have to come down to reflect the real quantity of production and savings in the economy.
The Eurozone crisis is a small yet significant detail in the wider debt crisis. Seventeen countries naively gave up their ability to manage their own interest rates and exchange rates in order to further the political goals of the European Union. These nations now lack some of the powerful tools which most governments have been utilising to combat the debt crisis - namely debt monetisation and external devaluation.
The risks posed by sovereign insolvency are economic. If a country defaults, its creditors will not get paid, and its credit rating will plummet. It does not impose some kind of danger on the existence of its currency. If Scotland were to go bankrupt and refuse to pay its creditors, there would be lots of angry banks and business owners, lots of people would lose money, and no one would want to lend money to Scotland ever again, or at least for a long long time. The Pound Sterling, however, would still exist. To say that a Greek default risks the survival of the Euro is nonsense. The only risks to the survival of a currency are its over-issuance by its producer (the central bank) or a voluntary switch to a different currency. A government that insists on propping up its banks and bond investors “at all costs” is much more of a threat to the currency’s survival than an honest government that admits when it is insolvent and pays the price.
2) The Eurozone crisis is only one element of the overarching crisis facing the entire developed world: the debt crisis, and under the current political framework, we will all have to pay for the profligacy of the few:
The current crisis faced by the developed world is a debt crisis. In other words, there is too much debt. There is too much public debt, too much corporate debt and too much personal debt. There is too much debt. There are more claims on wealth than there is wealth. For too long we have been exporting paper IOUs in return for real wealth, and now that those IOUs are being called in, our standards of living will have to come down to reflect the real quantity of production and savings in the economy.
The Eurozone crisis is a small yet significant detail in the wider debt crisis. Seventeen countries naively gave up their ability to manage their own interest rates and exchange rates in order to further the political goals of the European Union. These nations now lack some of the powerful tools which most governments have been utilising to combat the debt crisis - namely debt monetisation and external devaluation.
The debt crisis is not so complex when you break it down. Public debt is way too high. All the governments in Europe have been spending way more than they earn for a long time now, and making up the difference with borrowing. The UK is no exception. Corporate debt is also way too high. The majority of banks are heavily indebted and rely on regular borrowing in order to ‘roll-over’ their debts and stay alive. This is why a 'credit crunch' is such a big deal. If they found themselves unable to borrow money, they could quickly go bankrupt, prompting the government to step in and buy them up in order to protect the savings of ordinary folk like you and me. Personal debt is also way too high. The UK alone has close to some £1.5 trillion of outstanding personal debt.
In order for individuals to solve their personal debt problems, they must work hard, cut their spending and pay off their debt, or alternatively default on their loans and risk losing their property and their ability to borrow money for a long time. Corporations and governments face similar choices in order to solve their debt problems, in that they must either pay off their debts or go bankrupt, but they are not individual people, and no single person holds responsibility for their ‘credit rating.’ Corporations are distinct entities in that they are protected by limited liability under the law. When they go bankrupt, their assets can be seized by their creditors but the assets of the employees of the company are not at risk. This means that if you lend money to an overstretched bank, and it goes under, you may not get your money back. You cannot go knocking at the manager’s door afterwards claiming that she owes you money. International governmental lending could be viewed in a similar way. Governments do, in effect, borrow in our name, in that the government’s income, and hence its ability to repay its debts, is based on its ability to tax its citizens. But if you lend money to a foreign government and it subsequently goes bankrupt, there is little use in trying to claim that money back from that country’s citizens or its prime minister.
What this all means is that while the costs of sovereign debt must be borne by someone, in the case of sovereign default the costs to the taxpayer are limited, whereas if the debt is to be repaid in full, the government must either take on new debt to replace the old debt (an option no longer available to some European governments), or devise new taxes and spending cuts (austerity) so that the cost is spread around and borne by the whole population. The creditors (those owed) will undoubtedly lose out if a country defaults, so should we feel sorry for them? Whose fault is it that they foolishly lent money to these so heavily indebted governments?
The real split in Europe is not between the north and the south, or the Germans and the Greeks; it is between the productive sector – private businesses and people with jobs, all of whom pay taxes to the government, and the government sector - comprised of government employees and welfare/benefit recipients, all of whom receive money from the government, and the creditors (banks and bond holders), all of whom are also now reliant on the government in order to receive the money they are owed. (Without the taxpayer funded bailouts or liquidity programmes, the debtors (indebted governments and banks) would go bankrupt and these banks and boldholders would not get their money back). In other words, the majority of people, who are net payers to the government, are being forced to pay for the minority of people, who are net recipients from the government.
We can see this process in action today in Italy, for example. The productive sectors are being taxed in order to pay for the government sectors and creditors that are relying on the Italian government in order to be repaid. Greece, on the other hand, is receiving bailout funding from all EU taxpayers. The productive sectors of all the EU nations are being taxed in order to fund the government sectors of Greece (the treasury, civil service and welfare recipients) and those creditors who have lent to the Greek government (European banks, governments and bondholders). Either way the government sectors and their wider family of banks are draining resources from the productive sectors. In order to cut off this flow of savings from productive enterprise to the ever-growing political establishment and the mummified banking sector, we must default on the debt! Default will punish those who lent money to these spend-happy governments, and reward (or at least save from further punishment) the ordinary people who will ultimately have to pay for these debts through rising living costs.
Greece has long been the subject of speculation regarding sovereign default. The country is currently being propped up by the EU and IMF and remains solvent at the discretion of agreed emergency loans (bailouts). These loans add to the total amount owed by the Greek government, thereby worsening the solvency problem, and if they are to be paid in full, taxes will have to rise considerably and the standard of living of the Greeks will fall considerably. As Greece’s lenders are mainly other European governments and banks, this would cause a huge shock to the financial system and many banks would be under serious financial stress. Much of Europe could dip into recession as part of the wider ripple effects of such an event, particularly if combined with an exit from the Euro. As recently as November, the people of Greece and its lenders were slightly more optimistic that the country’s newly installed technocrat prime minister, Lucas Papedemos, would be able to relieve the debt burden and resuscitate the ailing economy. But irrespective of who has the top job in Athens, it has become clear that austerity, public sector reform and tax hikes are not enough, and as the economy slides deeper into recession, debt levels continue to soar.
The emergency loans to Greece are contingent upon specific mandated austerity measures. Greece promised to sell off €50 billion in state assets but has so far sold only about €1.5 billion’s worth. The government faces domestic opposition and a reluctance to ‘sell off the family silver’ at fire-sale prices. The country also pledged to lay off public-sector workers, overhaul tax collection, and make its economy more competitive but has fallen short in those areas as well. After two years of tax increases and wage cuts, Greek civil servants have seen their income shrink by 40% since 2010, and private sector workers have suffered as well. More than €58 billion has left the country as people move their savings abroad. According to a report issued last autumn by the Greek Co-Federation of Chambers of Commerce, some 68’000 businesses closed in 2010, and another 53’000, out of 300’000 still active, are said to be close to bankruptcy.
 |
| Prime Ministers of Europe and Greece - Barroso and Papedemos |
So far the EU’s policies have not helped in calming the markets and bringing down the borrowing rates for troubled economies. Officials from the Troika (The European Central Bank, the European Commission and the International Monetary Fund) are currently making arrangements with private sector creditors for an orderly semi-default, or as politicians like to call it: debt restructuring, in the form of a bond swap. Greece has a €14.4bn bond maturing on March 20th that it can’t afford to pay in full. A second €130bn rescue loan, crucial to keep Greece solvent, is dependent on this 50% ‘haircut’ being agreed with creditors.
Eurozone leaders have agreed to introduce imposed losses on creditors whenever a member state faces serious liquidity concerns that cannot be resolved domestically, they call this private sector “involvement” or PSI. The aim of this announcement could be to further deincentivise fiscal profligacy, as additional PSI risk would scare investors away from the issuers with large outstanding debt balances. However, this kind of institutionalised default agreement at a time of crisis sends a clear message to lenders, that Eurozone government bonds can no longer be regarded as a safe asset to be repaid in full, thereby raising borrowing costs even further.
Additionally, the EU has involved itself with all kinds of market interventions designed to limit the damage, but that will probably backfire in the long run. Firstly, the bond swap is specifically being ‘agreed’ with creditors so as to not trigger the Credit Default Swaps, which are derivative financial instruments designed to pay out when the underlying bond is defaulted upon. Of the €315 billion of Greek debt outstanding, only €7.8 billion is covered by CDSs, but the payout system has never yet been tested and the Troika officials fear their possible knock-on effects and resent the fact that certain hedge funds would profit at the expense of European banks, which have little insurance on their exposure. Secondly, the EU has legislated to ban short selling in certain markets, in a vain attempt to halt investor speculation on government bonds. The most recent proposals include banning the ratings agencies from reporting downgrades that harm investor confidence, as if shooting the weather man would make the sun shine.
Unfortunately Greece is not a one off case; Portugal is also not too far behind. While so far staying out of the spotlight and staving off the type of full-scale rioting seen on the streets of Athens, the citizens’ tolerance of deep austerity is wearing thin, and the financial markets continue to ‘price-in’ a higher likelihood of default. Mr Passos Coelho has so far been praised by EU and IMF officials for delivering on austerity reforms, but sooner or later the consequences of severe fiscal tightening, without the offsetting monetisation and devaluation enjoyed by countries outside the Eurozone, will push Portugal into the same downward spiral that has already engulfed Greece. The 50% Greek haircut will most likely not be enough, and a broader debt restructuring for the other indebted countries may also be inevitable. It is much better to get the delusions over with, take the hit, and give these countries a chance of coming out of their recession a few years down the line.
The activists in Athens are protesting against austerity, but in essence they are fighting to get their democracy back. The government, directed by the new missionary prime minister and overseen by the Troika, is being specifically mandated to push through an agenda that would be rejected if put to the people in a vote. The current state of affairs cannot go on forever. It is high time the politicians admitted the inexorable truth, that default is the only realistic way of pulling these troubled economies out of the mire.
No comments:
Post a Comment