No Cure for Sovereign Default
What happens when the fix is in, but nothing gets fixed?
This troubling question has vexed the financial markets for the last several days. One week ago the Eurocrats amassed a $1 trillion war chest (of borrowed money) to “fix” the Greek debt crisis and stabilize the euro. Seven days into the mission, the Greeks are as bankrupt as ever and the euro has tumbled to a new four-year low.
The European Central Bank – like British Petroleum – can’t seem to figure out how to contain the mess they made, much less how to clean it up for good. Just like the crude oil gushing out of BP’s underground well, Europe’s sovereign debt crisis continues to gush out of control and threatens to wash up on the shores of Italy, Spain and Portugal.
One week is not enough time to judge the success of the ECB’s $1 trillion “Euro Defense Plan,” but one week is plenty of time to judge its failure. This $1 trillion fix did not fix anything. It merely annoyed short-sellers for a couple of days and inspired enthusiastic gold-buying.
Rome wasn’t built in a day, of course. So we should not expect Athens to be rescued in a week…or ever. The country’s fiscal condition is beyond repair. Either Greece slips into the Mediterranean, figuratively speaking, or the euro does…or both. Borrowing $1 trillion to fight against the consequences of excess debt does not seem like a winning strategy.
In a worst-case scenario, the ECB will exhaust its cash, credit and credibility trying to save Greece…and will destroy the euro in the process. Best case, the “fix” will persuade a few Wall Street strategists that the “worst of the euro crisis is over” and will suck a few more suckers into the European sovereign debt markets before the situation gets REALLY ugly.
And it will get ugly…one way or another.
Many investors behave as if sovereign defaults are like polio: eradicated forever. These investors are half right. Polio has been eradicated.
Greece may not actually default, depending on the rescue measures that come its way. But Greece is already bankrupt. The creditors to Greece should understand that history is not on their side. In fact, the creditors to every sovereign borrower should understand that history is not on their side.
“While a European sovereign default has appeared inconceivable in recent history,” a recent Wall Street Journal article observes, “defaults and debt re-schedulings were actually a common feature of the European financial landscape throughout the nineteenth century and up until the end of World War II, according to the economists Carmen Reinhart and Kenneth Rogoff.
“Greece has defaulted or rescheduled its debt five times since gaining independence in 1829, the economists wrote in their paper ‘This Time Is Different,’ published in 2008 and recently expanded into a book. Spain has the lead in Europe at 13 times since 1476. Germany and France have both done it 8 times, while the UK has never done it since William the Conqueror invaded in 1066.
“Greece has existed in a ‘perpetual state of default’ since its independence,” the Journal concludes, “having spent 50.6% of those years in default or rescheduling, easily tops in Europe. Russia is next highest, with 39.1% of years spent as a bad debtor after defaulting or rescheduling five times.”
Governments default. That’s what they do. They tax; they squander the tax revenues; they default. This is the established unnatural order of the governmental world. The Greek crisis may be the first sovereign debt debacle of recent times, but it won’t be the last.