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Economic Life: There is nothing to stop a state in a single currency zone from defaulting. Look at New York City in 1975
Friday, 9 April 2010
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We can't go on like this, to borrow a phrase. Or at least the Greeks and the eurozone cannot. Jean-Claude Trichet was the latest senior European figure to try to calm things down yesterday.
"A default is not an issue for Greece," Mr Trichet told reporters in Frankfurt. He didn't convince many in the markets. While the Greek crisis sometimes feels as if it has been going on forever, and has the capacity to carry on doing so, we do seem to be entering some sort of endgame.
As ever, the markets are forcing the authorities' hands.
For those of us who thought the worst of the Greek crisis was over, developments in the past few days have been disturbing indeed: it feels a little like the prelude to the collapse of Lehmans in 2008.
The spread on Greek government debt over the relatively safe yield offered on their German equivalent, bunds, is up to 4.56 percentage points, a record. If you have the nerve, you can get around 7.5 per cent on Greek sovereign paper, the best rate by far across the single currency zone and since Greece finagled itself into the eurozone in 2001. Nerve seems to be in short supply in Greece itself, though. There has been a run on Greek banks, remarkably late in the story considering the circumstances, and the Greek authorities have had to offer special support. The UK banks have an exposure to Greece of £7.8bn, or at least they did; there is gossip that some large western banks are cutting their credit lines to Greece. Liquidity is becoming an issue (as it was with Lehmans in 2008, and Northern Rock).
Rich Greeks are apparently moving their money offshore or to foreign banks or cash – the very people, it has to be said, who have been evading their income tax and, partly, causing the crisis. Anyway the Greek banks are €10bn (£9bn) down, whatever the reason. The fear is that the banks with exposure to Greece will act as a transmission mechanism to spread the Greek disease around the Continent, and further afield. Greek officials are reportedly travelling to Washington to borrow $10bn (£7bn), and would like to renegotiate the rescue package agreed at the last EU summit. The media is stuffed like a ripe olive with speculation that the Greeks will soon have to activate the support package, or even default on its debt. Will they? Could they?
Like the possession of nuclear weapons, the hope was that the fact that the Greeks were armed with some impressive-sounding pledges from eurozone partners and the IMF would mean that the package would never actually have to be used. But barely two weeks after the breakthrough accord between President Nicolas Sarkozy and Chancellor Angela Merkel, the standby package of bilateral loans and "substantial" IMF assistance is proving little deterrent to the speculators. "We hope that it will reassure all the holders of Greek bonds that the eurozone will never let Greece fail," said Herman Van Rompuy, the president of the European Council at the time. "If there were any danger, the other members of the eurozone would intervene."
For a brief time, it worked. What seems to have spooked investors now is a combination of factors: rumours from Frankfurt that the Bundesbank is not that impressed with the IMF/eurozone rescue deal; those rumours about personal and institutional runs on Greek banks and renegotiating the deal; and the ever-impending rollover of Greek government paper, a side-effect of its shortish maturity. There is also an element of panic.
But let us face facts; the problem is the fundamentals of the Greek economy, and these were never going to get fixed in a matter of weeks or months. It will take many years, if then, to make the Greek taxation system work; make its statistics reliable and its economy competitive. The constant worry is that the political will is not there to implement reforms and tough decision on taxes and cut public spending, despite the sincere efforts of the Prime Minister, George Papandreou, and his colleagues. No one can be sure that the annual Greek deficit, about 12 per cent of GDP now, really will be down to 3 per cent by 2012 or so. The odds have to be against it.
So that is the problem with the IMF/eurozone rescue package: it might not actually work, no matter how strict it is, and even if all the well-known German objections to a bailout have really been overcome. The problem is that the Greeks will simply be unable to implement the harsh terms of any rescue; the only way in which the rescue would work is for it to be a simple subsidy, a gift. That would be acceptable to Paris; it is unacceptable to Berlin.
Hence the latest attack of the nerves. It isn't terribly helpful to canvas this, but the time may soon be coming when a Greek default might actually be the least worst outcome, all things considered. Or simply inevitable. Politically, it would be humiliating to the eurozone and a terrible blow to the European project, but it need not be terminal. Even now the much-feared "contagion" from Greece to Spain, Portugal and other PIIGS hasn't really materialised in the markets.
Despite the paroxysms of fear the possibility induces in Paris and, to a much lesser extent, Berlin, if Greece did default it would not necessarily mean the end of the euro.
Why? Because there is nothing to stop a state within a single currency zone from defaulting, and with remarkably few ill-effects on others. California may soon be the latest example in the US, its $46bn of debt proving difficult to service. New York City, in 1975, nearly went bust when President Gerald Ford refused a bailout. That episode famously gave us the immortal New York Daily News headline; "Ford To City: Drop Dead". We may yet see "Merkel to Athens: Drop Dead".
But the New York episode had no lasting effect on the cost of raising money by the federal government, or by other states. No more than did, say, the Mississippi default of 1840, when that state failed to honour $7m of bonds issued to establish two state banks that failed.
Beautifully engraved 1838 Mississippi Bond certificates, hand-signed by Governor Alexander Gallatin McNutt, go for $350 on eBay. I would advise any investor to hang one in a prominent position on their wall, a reminder of the risks of sovereign, quasi-sovereign and municipal debt – but also that the dollar survived. The turmoil around Fannie Mae and Freddie Mac makes a similar point: the Obama administration is able to borrow prodigious sums with ease, even after such ructions. So could most of the eurozone after a Greek default.
For the Greeks, a default would be very rough. But not so odd; Greece has been in default for more than half its modern existence. Yet, if she fixed her economy, the world would be happy to lend on reasonable terms. A Greek default would not be the end of the world – and not even the end of Europe.
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