Part of the problem is we have very few details. Yesterday we got a memorandum — an interim report — titled “Towards A Stronger Economic Union” that outlinedsome possible EU treaty changes written by Herman Van Rompuy, the European Council president.
Today "Merkozy" — French President Nicolas Sarkozy and German leader Angela Merkel—wrote a letter to Van Rompuy.
But both documents are sufficiently opaque — intentionally so — that we’re still left guessing what’s really going to happen.
I think that even the general outline, however, is a disaster.
In exchange for creating a stronger fund or group of funds to support European sovereign debt issuances, the euro zone countries are expected to hand over a good bit of their fiscal sovereignty. If a euro zone country violates the rules, the European Union can step in and force the country to make hard decisions.
It seems that one of the hard decisions that will be off the table will be not fully honoring sovereign debts. In other words, a default will be off the table. As journalist Felix Salmon explains, this “looks very much like an EU guarantee of sovereign debt.”
But consider how this will go over in the “debt sinner” nation. Germany will find itself forced to raise taxes or dramatically cut spending — in either case, far beyond what its domestic political situation will tolerate. The people will face taxation without representation, all on the word of foreign bureaucrats acting on behalf of foreign money lenders.
This might sound fair enough if it were just a case of a country of conmen, layabouts or cheats. If a well-off country simply over-borrows, overspends and refuses to tax enough to support its obligations, maybe they really are “tax sinners” who deserve “automatiche straffen.”
But what of a country that finds itself in unexpected dire economic straits. A global economic downturn seriously reduces GDP and raises unemployment. It finds that its tax revenues plummet because incomes are rapidly falling at the same time social safety nets are called upon more heavily.
This is not a far-fetched possibility. Spain and Italy are good examples of exactly this phenomenon.
As Paul Krugman has explained:
Before the crisis Spain had low and declining debt. Italy had high debt inherited from the past, but it was steadily working that debt down relative to GDP. Neither country was being profligate — that’s just not what happened. Since the crisis debt has been rising relative to GDP, but that’s what happens when you have an economic crisis.
Now a country in this position will undoubtedly have to suffer. But there is no moral reason that suffering should necessarily be visited upon its people to the exclusion of its creditors. The decision should mostly be a practical one of what combination of debt restructuring, tax changes, and spending reform will be best for the country in question.
Perhaps making sure creditors are paid in full makes sense, if that promises to keep funds flowing from international debt markets. But that might not necessarily be the case. If debt markets are skeptical about the country’s ability to stay current with its obligations, they may close the door on the country. In that case, default might well make sense. If you won’t be able to borrow for years, then it might not matter whether it's because your debt burden is viewed as unsustainable or because you just defaulted.
There are times when defaulting can actually increase access to debt markets. This happens all the time in bankrupt private debtors. They find they cannot borrow while under their current debt, so they get out from under it. This process works in public debt markets, too. Do you think Goldman Sachs would refuse to lend to a debt-free Italy just because the default had ruined, say, Societe Generale?
In any case, the wisdom of paying off creditors in full or forcing them to share the burden is at least debatable. The idea that foreign bureaucrats will be able to force the decision to go one way is an invitation to revolution. At the very least, we can expect widespread social disruption — riots, strikes, political upheavals — if the EU ever really tries to “punish” a “debt sinner.”
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