Debt Crisis ABCs

Debts so large that a country can’t repay them may be erased in three ways. One is a transfer of cash (a bailout), another is the purchase of the debt by the country’s central bank (printing money), the third is outright default. Most countries print money—thus to repay numerically fixed debt by cheapened money. The consequences are dire but ultimately, self-correcting. Among them is that the country’s exports, priced at inflated rates, becomes less desirable. It cannot sell its debt except at increasingly high interest rates. Eventually its currency is devalued. That in turn results in very high costs for vital imports, like oil. Money tends to flee the country, thus stifling development. Countries tend to run deficits because it is easier to increase services and to cut taxes than to tax their industry and public.

When the country is part of a larger entity, such as the European Monetary Union, the temptations remain but the painful consequences are shared by others. Members of the EMU will be inclined to use a bailout rather than suffer the consequences in an inflated Euro—and this especially if their own banks hold the bonds of the offender. Thus the first option comes into play. Some label this the moral hazard of monetary unions: incentives are present to enjoy the benefits of bestowing goods while others help with the paying of the bills.

In Europe Greece is the offender, and a Round One bailout has been approved—alongside a handful of demands for reform. Greece has not delivered on the reforms, hence Germany now opposes Round Two. And thanks no doubt to strong German signals, the European Central Bank (ECB) has drawn back from the second option, namely printing Euros with which simply to buy the outstanding debt of Greece, Spain, and Italy—thereby restoring “confidence.”

Whose confidence? Ordinary people’s? Paul Krugman’s? Krugman today vented his displeasure in the NYT with the ECB’s refusal to print money—and labeled Germany’s and others’ pressures as “moralizing.”

The moral problem that here arises is the tendency of governments to skate on the thin ice of deficit finance, hoping that the future—or more disciplined agents—will bail them out.

That in the EU individual states, like Germany and France, have to undertake bailouts (and sell them to their own people) arises from the EU’s limited powers. It’s not a nation but something short of that (see last post). Bailouts in this country are undertaken by the nation as a whole, thus by Congress. Those actions are also often dubious—the consequence of letting shady actions proliferate. Indeed the only reason why Germany and others have voted for bailouts is because they are themselves endangered by an inflating Euro if the ECB does the job instead of them.

The holders of the debt, in Greece and elsewhere, are investors, banks. They too, I suspect, winked a little when they lent to Greece, more freely surely than they should have, knowing that now, in defense of the mighty Euro, their money would be safer. Default? Everybody shudders. Ultimately it would result in a credit crisis. And if it is large enough, the walls of almighty Capitalism might begin to shake, rattle, and roll. But wouldn’t that be, like, the End of the World?