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%.
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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.
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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.