Europeans Are Thinking the Unthinkable: That Debt Defaults Might Make Sense

Instead of struggling to keep the euro zone together, default may be less painful in the long run for the people of overindebted countries

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SUSANA VERA / REUTERS

A man walks past a closed-down business in Madrid on March 27, 2013

The euro-zone crisis has slipped off the radar screen during the past couple of weeks as gun control and the Boston bombers have dominated U.S. news. But none of the euro zone’s problems have gone away. Political crises beset France, Italy and Spain. Smaller countries, from Portugal to Cyprus, face even more pressing financial troubles. Germany grows less and less willing to foot the bill for bailouts. And for the first time, serious public figures in Europe have begun openly discussing the pros and cons of allowing countries to default on their national debt.

There is, in fact, a historical case for tolerating default. Argentina suffered a financial crisis in 1999 that led to a period of high unemployment. Over the next several years, it became harder and harder to maintain the value of currency. In 2002, the country defaulted on more than $100 billion in debt. Inflation soared, and workers’ purchasing power plummeted. Savers lost a big chunk of their money. But a year later, growth bounced back to an 8% to 9% annual rate, and wages rose even faster.

The same issues arose during the 2008 banking crisis. Ireland bailed out its banks, while Iceland couldn’t afford to and allowed a partial default. The results were that Ireland had no inflation, but unemployment topped 14% as growth ground almost to a halt. By contrast, in Iceland the currency lost almost half its value and inflation reached 5.4%. However, economic growth picked up slightly and unemployment didn’t rise much above 6%.

(MORE: Why the Case for Austerity Took a Big Hit)

In all these cases, policymakers had to choose whether working people or financial interests should be the ones to suffer most during a serious economic crisis. Default hurt affluent savers and financial institutions, but proved to be better for ordinary workers over the long term. What is happening now in Europe is that populations are resisting further austerity. In response, politicians and technocrats are beginning to question whether default might ultimately be less painful than doing what will be required to keep the euro zone together. Consider the latest developments in these six countries (from west to east):

  • Portugal. In an interview on a public-broadcasting station two weeks ago, former Prime Minister and President Mário Soares argued that default was preferable to greater austerity. In the interview, Soares specifically cited the precedent of Argentina.
  • Spain. For the fifth year in a row, Spain remained the euro-zone country with the highest overall unemployment rate, at 25% for 2012 (Greece may be No. 1 this year). As a result, Spain faces a range of crises — from the possible secession of Catalonia, as that wealthy region tries to escape austerity, to the potential slaughter of rare horses that are too expensive to keep.
  • France. After less than a year in office, Socialist François Hollande is the least popular President in more than 30 years. Financial scandal in his administration is one reason, but a more serious problem is the downturn of the economy, with France likely to fall back into recession this year.
  • Italy. February’s elections resulted in a deadlock, as more than a quarter of the vote went to an antiestablishment protest party. That made it impossible to elect a new President, so the 87-year-old incumbent has been re-elected to another seven-year term. He will have the right to call new elections, if the parties cannot form an effective coalition government. One thing is clear: it is unlikely that there will be a stable leadership capable of carrying out difficult economic policies.
  • Greece. Austerity in the country has become so brutal, according to the Atlantic, that children are starving. That may be alarmist, but conditions are bad enough that the most productive workers are emigrating. This brain drain will make it much harder for the economy to recover.
  • Cyprus. The current bailout plan has such harsh terms that Cyprus will be forced to sell off all the assets it can. A recent editorial in one of the island’s newspapers says: “We may wake up one morning and find the country has completely shut down, crushed under the weight of its mounting, unserviceable debts with no banks, businesses or services able to operate.” The alternative, the editorial concludes, is to exit the euro.

Since Germany has financed the largest share of bailouts to date, the country’s willingness to keep doing so is key to the survival of the euro zone. From that perspective, a couple of recent developments are ominous. Two weeks ago, a group of economists and university professors launched a new German political party committed to the “orderly dissolution of the euro.” National elections for the lower house of Parliament are expected to be held by late September.

Yesterday, German Chancellor Angela Merkel stated that countries in the euro zone must be prepared to give up some control to European financial institutions. Her words will almost certainly provoke further resistance from countries with high unemployment. Yet any softening of Merkel’s stance will help the new anti-euro party draw voters away from the governing coalition in the upcoming elections.

(MORE: Why Austerity Is a Dangerous Idea)

With the social fabric tearing in many countries, default is looking increasingly attractive. The top priority for poor countries will be to revive short-term growth even if there is a longer-term cost. And at some point, it will be cheaper for affluent countries to clean up the financial mess caused by defaults than to keep passing the hat for those in trouble. Mainstream opinion is seriously considering the idea that everyone may end up better off if problem countries simply leave the euro zone with as little fuss as possible. And once such an exit becomes thinkable, it may well become inevitable.

8 comments
BobFromDistrict9
BobFromDistrict9

I have one question. How much of the economic crisis, how much of the suffering, the starving children, the impoverishment, are due to corruption of the financial institutions. 

Note: I am accusing them of corruption, not error or failure. 

If the answer is, as I expect, somewhere near 100%, then default is not only the obvious and best answer, it is the morally correct answer.

piter
piter

I read this article with a lot of interest because I am currently reading a very interesting book on Goodreads called THE 5-STAR BUSINESS NETWORKS by Vivek Sood which argues similar points in a much more forceful and coherent manner. Books have been a part of my life since the beginning. My mother once told me her and our neighbor would sit together and read to me and the other woman’s baby, who was later to become my childhood best friend. I didn’t start reading Wharton and Steinbeck until much later, but we have to start somewhere. I will encourage the journalist to talk to the author of the above book to get deeper insights into the material he is covering. <a href="http://www.amazon.com/5-STAR-Business-Network-Generation-Corporations/dp/061579419X/ref=la_B00CF5L5NY_1_1?ie=UTF8&qid=1366329912&sr=1-1">THE 5-STAR BUSINESS NETWORKS </a>

TheAnvil
TheAnvil

Argentina continues to deal with the fallout from their defaults, including legal action here in the US.Their financial mismanagement continues to have serious repercussions, with 10 year bond yields of nearly 17%. This is more than 5% higher than countries like Kenya, Pakistan and even Greece.

In other words, no one will lend them money at an affordable rate, because no one trusts them. Their economy is in shambles.

If that’s the example they want to follow, ruin lies ahead.

roknsteve
roknsteve

The bankers caused this so please default and take back your power and lives from them.

paul.abbotson
paul.abbotson

So why does the  Time journalist describe the news that Greek children are starving as perhaps 'alarmist'? True,  the sons and  daughters of the super-rich minority are carrying  on as usual. However, many middle class kids, though adequately fed,  are being withdrawn from private schools as their parents can no longer afford tuition. There are many really poor people; those below the conservative   poverty line  are in excess of 30 per cent of the population. People have committed suicide because they cannotput bread on the table or their homes were repossessed by the bank.

Yet the IMF insists on  every person paying  income tax and the poll tax no matter how low their income. Imagine how high officials in Eurogroup with six figure salaries and expense perks would cope if they had to live on  350 euro per month. That the same officials insist that the Greek poor do so is obscene. There are many households with  both parents  unemployed and the IMF has insisted on  unemployment benefits being  cut as well as compensation for dismissal. Many are not lucky enough to have had employers who insure them or union s to protect them.

It behooves a foreign journalist, before passingjudgement to visit Greece and make a comprehensive tour of areas of poverty in the cities and countryside with some Greek journalists to translate and explain the situation first hand. Public school teachers  in poor districts of Athens comment that children often come to school without having eaten breakfast and money to buy lunch. We have actually seen a ten-year old girl faint in a bakery shop. A doctor was called and he  opined that she had not eaten enough, from poverty not anorexia. Fortunately Greeks as a people are generous, even those who are themselves poor but still havejobs orpension donate food to the church to distribute to the needy. Most Greek emigrants are bright young college graduates who lack connections with politicians and the elite whose own kid get plum positions. Most of the young folk who seekemployment abroad are very smart, many of them will not return. The IMF is killing the country, and seems to be doing the same throughout southern Europe.

paul.abbotson
paul.abbotson

@roknsteve

The money received by Greece in periodic doses to avoid default is mainly from Germany, whose banks have the largest holdings of Hellenic Republic bonds. After torturous ‘negotiations’ with the Troika every three months most of the money dose earmarked for Greece goes into an escrow account. As part of a bizarre financial charade, a small part of the amount is released to the Greek government to run itself, pay public workers’ wages, state pensions, health, defence etc. In the meantime the German banks make hundreds of millions in profits on the interest paid them. The Average Schmidt household in Germany who-unlike a wealthy banker does not havethe means to avoid much tax legally -is led to believe erroneously that he is taxedsolazy Greeks can sit in coffee shops. He is unaware that most of his tax money earmarked for Greece ends up bailing out his own banks. Meanwhile the Constandinou household in Greece, average working stiff taxpayers, is also milked to pay his country’s creditors with higher tax rates at the same time suffering from hefty cuts in his family’s wages and pensions while living in fear of unemployment in a regime without consumer price controls or an attempt to break up local cartels. If three years ago a technical defaulthad been achieved by mutual consent betweenthe southern European countries and their mostly northern creditors via rescheduling most or some of the debt while maintaining interest payment Europe would be in much better shape than after three years of taking the IMF's toxic cure.