German Finagling of Rules, Bailouts and Bond Markets Send Eurozone Hurtling Toward Oblivion

by Avinash D. Persaud, Peterson Institute for International Economics

The Greek tragedy contains more than its fair share of irony. Perhaps the biggest irony of all is that in the drafting of the Maastricht Treaty on Economic and Monetary Union in the late 1990s, it was Germany that insisted on the “no bailout” clause. A Greek default in 2010 would have avoided Greece’s fiscal troubles cascading into an existential moment for the European Union. This is something many, including myself, proposed. But Germany and France did not want that. They feared that the damage it would do to the German and French banks that had gorged themselves on high-yielding Greek debt would further endanger a fragile global financial system. More debt was heaped onto already impossible-to-repay levels of debt. Greece’s economic sustainability was sacrificed on the altar of European financial stability.

Benefits to a Default

Once a country is in a fiscal mess, there are economic benefits to a default. The object is not to punish creditors, but to allow a country to quickly return to the capital markets. The shame of default often leads to new political leadership, which gives credibility to new fiscal commitments. In the shadow of default, creditors and borrowers act more responsibly. Over the course of financial history, international money often returns surprisingly fast after a default. There are a multitude of potential complications. If you are small enough or uninteresting enough for international portfolios to suffer no loss by ignoring you, the return could be protracted. Debt crises also breed a debtor’s defiance that can keep foreign creditors at bay.

In Europe there is an additional challenge. To create a single financial system, it was thought necessary for the European Central Bank (ECB) to treat member state debt as largely equivalent to each other. But this would

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