Der Spiegel has an informative 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.”
Bankruptcy, of course, is not the precise word, because there isn’t a mechanism for bankruptcy in the case of states. But the general point that “bankruptcy” drives home is clear; and I’d add the fact that Brussels would have to address this, one way or another, and this is oddly closer to bankruptcy (maybe) than simply the creditors trying to cobble together to schedule a workout with the insolvent sovereign. There’s no code and there’s no legal structure as such, but there is an overarching legal and political structure that presumably can’t just ignore it and so would have to behave in some kind of quasi-governmental way.
Or am I dreaming? What would Brussels do? In any case, 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.) (Cross-posted from OJ.)
Jon Rowe says:
So far, I haven’t seen any serious reason why the Euro should be valued so much more than the dollar as it currently is. Granted, the US is in a mess and we are printing a lot of $$ to try to get us out. But, it’s not as though any of the other world currencies — or the Euro at least — are not in a similar messes or doing anything with their fundamentals that merit the world investing there instead of in the dollar.
If Greece does default, perhaps that will pop the Euro’s overvalue bubble vis-à-vis the dollar? Or can anyone explain to me why the Euro should be valued so higher than the dollar with nations like Greece and Italy (and others) in the Eurozone?
December 9, 2009, 12:27 amMark N. says:
One guess is that investors consider it more likely that the U.S. will respond to its fundamental problems via currency devaluation, than it is that the Eurozone will do the same thing, because the weakest Eurozone members aren’t in a position to control the ECB.
December 9, 2009, 12:50 amRandy says:
Well, there is a reception at the Greek Embassy tomorrow night. I had no idea Greece was tottering! I’ll bring it up with the Commerce Secretary…..
December 9, 2009, 1:04 amLior says:
Well, if central banks are betting on Greek solvency (by buying Greek bonds) then these banks might pressure their taxpayers to bail Greece out.
December 9, 2009, 3:37 amKaonashi says:
Suddenly Britain is starting to look pretty good in their steadfastness against switching from the pound to the euro.
I’m surprised it hasn’t been mentioned the impact this would also have on the wider debate in regards to basket currencies. There are definite advantages in some situations to having a currency based on the economy of more than one region / country but if Greece defaults then it will shatter confidence in the entire concept of a region-wide currency, of which the Euro is the only one right now although not the only one that’s ever been suggested.
December 9, 2009, 3:50 amApu Nahasapasapeemipetilon says:
Economics- it’s all Greek to me.
December 9, 2009, 4:15 amEvilDave says:
Well, the Democrats always say they want the US to be more like Europe.
December 9, 2009, 4:16 amTracy W says:
I don’t follow the problem. If Greece goes bankrupt,how does that threaten the euro just because Greece is part of the euro? Is there a history of big bankruptcies by private companies wrecking their country’s currency?
December 9, 2009, 4:53 amRicardo says:
The Occam’s Razor answer is that short-term rates and yields are still lower in the U.S. than they are in Europe. Here are short-term government yields for U.S. versus Germany:
3-Month 0.02% 0.34%
1-Year 0.27% 0.77%
2-Year 0.73% 1.23%
I’m not a trader but I think a ~0.5% spread is enough to do a carry trade.
December 9, 2009, 7:47 amlukas says:
Well, it’s pretty much an open secret that Greece only got accepted into the Eurozone by fudging their numbers to fit the Euro convergence criteria. When they default, the Germans will be more tempted than ever to have the Greek seat on the ECB’s Governing Council revoked and relegate them to the status of a “euroized” country, akin to Montenegro, Kosovo (and possibly Lithuania in the future).
Besides, Greece’s share of the euro economy is not nearly big enough to seriously impact the viability of the euro. Italy and Spain are the countries that will make the currency union implode.
December 9, 2009, 8:20 amTweets that mention The Volokh Conspiracy » Blog Archive » Threat of Greek Sovereign Bankruptcy and Possible Consequences for the Eurozone -- Topsy.com says:
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December 9, 2009, 10:19 amTatil says:
I don’t see the connection between a possible default of Greece and euro’s reliability, either. Sure, if the investors believe euro will be inflated away to help out Greece and a couple other countries. Otherwise, there are many companies and even countries borrowing in dollars or euros and they declare bankruptcy every now and then. Why is this different?
December 9, 2009, 12:00 pmInternational Finance Lawyer says:
A member country default should have no more direct effect on the euro than a state or municipal default in the US should have on the dollar. For that that matter, it should have no more effect than any industrial or sub-sovereign default would have on its home currency.
Any default reduces the liquidity of the creditor. If the securities are sufficiently broadly held, the default could affect the liquidity of the market as a whole. But that is no different from any other default — sovereign or private-sector — which a monetary authority mitigates by injecting liquidity into the market.
While the European Central Bank could mismanage the potential liquidity crisis, and the markets customarily show some hysteria when presented with something novel, this seems remarkably Chicken-Littlish to me.
December 9, 2009, 12:33 pmHarryEagar says:
Dibs on blaming Barney Frank.
December 9, 2009, 12:46 pmMartinned says:
The US Federal Reserve have always cared less about inflation than the Germans. Since the ECB is set up to be the German Bundesbank writ large, long term inflation expectations are still lower here than in the US.
While the absolute difference in value between currencies is a matter of historical accident, (We could have created the euro 10 years ago at a rate 2 or 5 times higher than we did, at, say, 4,40 guilders per euro or 11 guilders per euro instead of the rate they actually used of Hfl. 2,20371/€. That’s a question similar to that of stock splits on the stock market, i.e. why do shares on the London stock market tend to cost a few hundred pence, max, instead of $ 50 or € 50.) the changes in the exhange rate are driven by the difference in the risk-free (interest) rate, which is still higher in the US due to higher expected inflation in the longer term.
This is also where the Bretton-Woods story comes in. As long as the dollar is the international reserve currency of choice, that allows the US to print money without consequences, because a lot of that money is going to end up in somebody’s vault somewhere. If and when the dollar loses that status, the US will have to watch its sins like the rest of the world.
December 9, 2009, 12:58 pmHankP says:
I doubt a Greek default will be allowed to happen. If the rules in the Euro zone forbid one country from lending to another directly, they’ll just arrange a three way deal with the money being “laundered” through London or New York. In the scale of problems that have been handled in the last two years, this one is pocket change.
December 9, 2009, 1:09 pmMartinned says:
There’s no rule against one country lending money to another. There’s only a rule against the EU or the ECB lending money to Greece.
December 9, 2009, 1:14 pmBrett says:
Could they expel Greece from the EU over it? That would keep confidence in the Euro, but put Greece in an even worse position and undermine confidence in the overall stability of the European Union.
I suppose the alternative, to avoid moral hazard, would be a bailout of the Greek government – with some truly strict and extremely onerous conditions that they would be required to comply with, or risk being ejected from the EU.
December 9, 2009, 2:49 pmMartinned says:
It is not possible to expel anyone from the EU. (Or from any other international agreement, for that matter. Cf. the trouble with Russia not ratifying the 14th protocol to the ECHR, causing the entire mechanism of the ECtHR to grind to a halt, because they have more cases than they can handle under the old setup.)
Under art. 7 TEU, a Member State can have its vote in the Council suspended, or other (unnamed) rights arising under the Treaties, but only if the European Council determines that there is a “serious and persistent breach” of the values referred to in art. 2, i.e. such things as democracy, rule of law, etc.
The place to look for good, solid blogging on European economic policy is A Fistful of Euros. Some of the bloggers there are serious macroeconomists, who blog with all the cool graphs that us economists love so much. But they also know a great deal about the EU law and policy aspects of the story. Their most recent post on Greece is this one, from Monday. The conclusion of that post is:
December 9, 2009, 3:48 pmNorthern Dave says:
Greece will be foreclosed on by Germany and Athens renamed “Bad Merkel”. Peter Mandelson will declare no problem ever existed and eliminate any employment over 1 Euro an hour in total renumeration (including breathable air)….(yes I’m aware he no longer technically holds the EU Post while he props up GB – Gordon Brown that is – but if you control the media?….)
Either that or they’ll print up a passel of Euros in the Netherlands and use it to pay off the Greek debt just like they did with the banks.
December 9, 2009, 4:55 pmMartinned says:
The problem with one or more member states stepping in to fix this problem is that EU MS don’t trust each other that much. After all, they are sovereign states, and ultimately not even the EU can make them do something they don’t want to do. (Like keep their budget deficit under 3%, as they are required to do under art. 126 TFEU, as implemented by Protocol No. 12.) One MS isn’t just going to give money to another without some strings attached, and how do you police those strings?
Countries like Germany would much rather bail out their own banks again if they run into difficulties over this, than bail out the Greek government. Greece is small, so let them clean up their own mess.
December 9, 2009, 5:12 pmJon Rowe says:
Thank you for your answers.
December 9, 2009, 7:59 pmNorthern Dave says:
I’m not sure I’d agree that they are sovereign states anymore, Martinned. As of December 1st, 2009 the Treaty of Lisbon is law in the EU and far more far-reaching than most realize. The Central Powers are very, very cautiously and slowly implementing the actualization of the new United States of Europe, but under the structure as it stands this is more analogous to South Carolina teetering on the edge of bankruptcy with respect to the US than an independent nation in a coalition. The Illusion of National independence is temporarily being maintained, but the real power in Europe is now in the European Parliament and will solidify quickly there unless one of England, Germany (who want this more than anything as they dominate the EU parliament numerically), or France pulls out very quickly (which barring a revolution in one of England or France I don’t see).
The EU Central Power will decide who fishes where, who lives where, who works where, who gets which contracts, what laws apply, and will form an Imperial Forces quickly to enforce their will.
Rome is reborn. (and having to bail out the Greeks :-) Jean-Claude Juncker: “I don’t have the slightest suspicion that Greece could go bankrupt — anyone speculating that this will happen is deluding himself,”)
December 9, 2009, 9:40 pmMartinned says:
@Northern Dave: To the extent the real power is in Brussels, it certainly isn’t in the European Parliament. It might be in the European Council/Council of Ministers, where the Member States sit, or in the European Commission, the Executive Branch of government, but (still) hardly in the EP.
In many areas of law, the EU can make its rules stick, particularly with regard to specific laws that the Member States are required or forbidden to enact. The budget, on the other hand, is a different story. It cannot easily be boiled down to specific, enforceable legal rules. Even a rule that says: “Balance your Budget, and any budget that isn’t balanced is void.” would still be difficult to enforce. Is anyone really going to force a Member State to turn the lights off at midnight?
I think the kinds of strings that one would want to attach to a bailout are more like the budget rules than like the Common Market rules. In fact, just look at the bailout of the banks: Governments all over the world are having all sorts of difficulty trying to get the banks they bailed out to hold up their end of the deal.
December 10, 2009, 11:10 amMartinned says:
Anyway, the game is on.
December 10, 2009, 12:22 pmNorthern Dave says:
I think these things are one of the main concerns in Britain. The Central European view of EU authority to dictate things like working conditions (eg. hours of work) runs contrary to what many working class Britons are comfortable with. I wonder if a more Swiss-style model will be necessary if the EuroState is to be successful (it strikes me the Germans believe that all things will be run by their Prussian-descended bureaucracy and the peasants in the rest of Europe will finally obey their dictates as they ought to have all along….I don’t think Europe’s history allows for the success of that model).
If rescuing Greece involves harsh working condition imposition – when such draconian attempts led to the unrest there and the government change – won’t the EU be seen by the working class all across Europe as just a new Tyranny?
December 10, 2009, 3:55 pmMartinned says:
Who said anything about attaching anything working conditions-related to a Greek bailout? There are already a number of working conditions directives the same way the US has the Occupational Safety and Health Act. Those are enacted the usual way, with a Commission proposal followed by votes in the Parliament and in the Council, both of which include representatives from Greece. Also, Greece just replaced its centre-right government with a centre-left one, so why would they object to social-democratic legislation?
Of course, your general point is well taken. In Eurospeak, it’s called subsidiarity and proportionality. That is why I am often sceptical about new EU initiatives, as well as a number of changes made by the Lisbon treaty, even though I am generally passionately pro-EU. Ever since the 1992 Maastricht Treaty, the drafters of the various treaties have tried to formulate this principle in such a way that it can be made legally enforceable, but so far with little success. (The Lisbon Treaty devotes this protocol to the subject, requiring yet more disclosure by the Commission justifying every proposal, and creating a “yellow card” procedure whereby national (i.e. member state) parliaments can step on the brake if they think the principle of subsidiarity is being violated.)
BTW, none of this is “the game” I had in mind, if for no other reason than that neither the EU nor the ECB has the authority to bail out Greece. The “game” I meant was simply the political game of dancing on hot coals while trying to sort out whether anyone is getting bailed out, and, if so, by whom.
December 10, 2009, 5:48 pmChris Travers says:
Of course Greek tax accounting requirements are about as sane as their national debt practices….. I am surprised their economy hasn’t imploded already….
December 10, 2009, 9:38 pmMartinned says:
As the Mythbusters proved recently: you’d be surprised what kinds of things you can hold together with duct tape.
December 10, 2009, 11:17 pmblue monkey says:
Greece and Spain won’t pay back. This was a calculated Risk, and a Lesson for the Banking System. The only thing Germans can do is:
May 10, 2010, 11:03 pmREPOSSESS 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
U.S.A must REPOSSESS 170 F-16 Jet Fighters from Greece, … the rest is gone with the wind …forever …
Greece must stop paying lucrative pensions with borrowed money, reform the free health care system, and cut down, 4 times the military budged.
Greece’s problem is too much debt. Greece has a budget deficit of 12.7% of GDP – meaning that the country is spending 12.7% more than the value of one year’s economic output.
Greece is no different to a serial credit card borrower who can’t pay back his loans. But just like a serial credit card borrower, as long as Greece keeps relying on borrowed money to fund itself, the problem won’t go away. It will just get worse.
http://www.defenseindustrydaily.com/Greece-in-Default-on-U-214-Submarine-Order-05801/
Don’t worry; the ECB, the Fed or both will print the money.
And all of us will share the pain, with our hard-earned money.
Bad is never good until worse happens.
Nery Bloeser says:
Germany, only a short time ago, raised the retirement age to 67, while Greece lowered the retirement age to 58. About the same time riots in Greece by students and Union members had the country about to implode. If anyone rioted it should be the Germans who are going to have to foot the bill because for the most part it’s the only county keeping Europe afloat. Soon Portugal and Spain will be in almost the same boat as Greece. Not long after that Italy is about to fall. If the Italian economy fails look for the Northern League to secede leaving the southern half of Italy to fend for itself.
May 21, 2010, 8:23 pmNorthern Dave says:
Umberto Bossi for President of the Republic of Lombardy!!
May 21, 2010, 8:49 pmNorthern Dave says:
Hmmm….wait I forgot about his ties to the SSPX….maybe not.
May 21, 2010, 8:57 pmbusiness lawyer says:
hah… only in small business
July 16, 2010, 7:16 pm