How Worried Should You Be About A Greek Default?

My answer:  not at all.  In fact, the opposite:  we should all be praying for a Greek default.

The Greek default business has been mostly off the front pages of the U.S. papers for a while, but that doesn't mean that it has gone away.  Greece has some big debt payments coming due as early as June, and many think they won't have enough money to pay without some infusion of cash from EU colleagues or some "restructuring."  ("Restructuring" means that the creditors agree to take less than they are owed and not call it a default.)  And thus endless "negotiations" take place over some kind of "deal" to avoid default.

The benefits to everyone else of Greek default are obvious.  Greece's politicians have made ridiculous spending promises to their voters, counting on other people's money to fulfill the promises.  They way overpay their government workers, demand pitifully low productivity, give out lavish pensions and benefits, don't enforce their taxes -- and pay for it all with borrowing.  When they default the borrowing spigot turns off, at least for a while.  They literally can't pay their bills at the level they are running, and they will have a modicum of financial discipline forced upon them.

Of course there would be losers.  But the only obvious losers are the holders of the defaulted debt.  The people who have lent money to Greece in any recent time frame are not people that anyone should feel sorry for.  Greece's financial irresponsibility has been obvious for many, many years.  Lenders to Greece have gotten premium interest rates for most of human memory.  Why does anyone else owe them a bailout?  Other than lenders to Greece, the potential losers from a Greek default are not obvious at all, and would only emerge if there is some kind of systemic financial crisis that follows the default.

And yet these endless negotiations continue, with the seemingly universal assumption that there will be a bailout or restructuring of some kind if only the recalcitrant Greeks agree to sufficient "conditions."  What I don't understand is, why is anyone even talking to them?

The only answer I can find boils down to -- fear of the unknown.  As one of many examples, consider Rick Moran today at American Thinker:

Thankfully, American banks have very little direct exposure to a Greek default.  But the wild uncertainty of what would happen to the rest of Europe in the case of a Grexit is extremely worrisome to American financial institutions. . . .  But no one in Europe is sure if these measures [taken by European pooh-bahs so far] are enough.  That's because managing expecations following a Grexit cannot possibly take into account the panic factor.  And as swiftly as crisis can move in these days of instantaneous news reporting and speed-of-light transfer of funds, it is more than a distant possibility that panic could overwhelm the system and start a domino effect of collapsing banks in every corner of Europe.

In an afternoon, the international banking system could collapse.

Really?  Of course, I can't predict what will happen with certainty, but frankly this is ridiculous.

And why is this the unknown?  Sovereign defaults happen all the time.  Argentina, with about 4 times the population and two plus times the GDP of Greece, defaults regularly -- most recently last year, and the time before that in 2001.  Venezuela, well over double Greece in population and close to double in GDP, is about to default, and nobody seems to think that that poses any great threat to the world financial system.  Russia, ten times or so the size of Greece in population and GDP, defaulted in 1998.  And I could go on and on.

Well, Greece is part of the Euro.  Does that make a difference?  Only in the sense that nobody knows.  Here is Charles Wyplosz writing today at the Credit Writedowns site:

What makes the coming event interesting is that it will be the first time that a default occurs within a monetary union.

I would dispute that.  Eight U.S. states defaulted on their debt in the 1840s.  Doesn't the U.S. qualify as a monetary union?  Nobody bailed those states out and they didn't exit the dollar.  Is the world different today?  Sure.  But do any of the differences constitute a reason to panic?

I have a very simple proposition:  If the EU can be buffaloed into bailing out Greece by use of threat of "global financial collapse" or something like that, then there is no end to it.  Sooner or later we either have to pour the entire world GDP down the infinite maw of Greece, or toughen up and let the default happen.  The financial institutions need to learn now how to harden the financial system to deal with defaults, or else the Portugals and Italys of the world will follow Greece's example and hit up everyone else for a bailout.  Best to do the default sooner rather than later. 

Europe Bails Out Cyprus

The news on the Cyprus bank bail-out is that in its final iteration it is a lot closer to just letting the banks fail.  The question I have is, why didn't they go all the way?

The basic outlines of the deal, struck Sunday night, are here in the Guardian (and in many other sources):  Bank Laiki is being closed.  It's insured depositors will get their 100,000 euros, and above that depositors will lose much or all of their savings.  Bank of Cyprus will be "heavily restructured," so the details of who will end up where are much murkier.  Presumably, the 100,000 euro deposit guaranty will also be honored.  Oh, and the ECB coughs up 10 million euros.  Presumably the latter is "needed" because the tiny government of Cyprus does not have the money to pay off its 100,000 euro deposit guaranty.

This deal is much closer than the previous versions to what would have happened if the banks just failed under the existing rules and with no bailout.  In the "just fail" scenario, I would think that the under 100,000 euro depositors get paid until the government of Cyprus runs out of money.  Remaining unpaid depositors, both under and above 100,000 euros, become equity of the restructured bank.  Non-depositor creditors and prior equity get wiped out.

There are lots of reasons why the "just fail" scenario is preferable.  In the "just fail" scenario, prior management has no right to continue, and the prior depositors, as new equity, can hire new people with a new approach.  In the "just fail" scenario, the cents on the dollar going to uninsured depositors turns on how under water the bank is, thus giving depositors the next time around an incentive to monitor the finances of the bank they invest in. 

So why not go that route?  It's the same story heard in the Greece/Spain crises over the past few months.  As articulated by Michalis Sarris, Cyprus' Finance Minister:

It's not that we won a battle, but we really have avoided a disastrous exit from the eurozone.

Good threat Mr. Sarris.  But why exactly would Cyprus exit the euro?  None of the U.S. states that defaulted in the 1840s tried to exit the dollar.  (And at the time many thought they had a right to exit if they wanted.)   Frankly, I don't believe for a minute that Cyprus would have done it.  The benefits of being in the euro are too great.  Yes, you have to roughly balance your budget and not take on obligations far in excess of your GDP to foreign bank depositors.  That's the regime under which the U.S. states operate, and it's the best thing that ever happened to them.  The Eurozone's problem is that other countries, mostly Germany, are so committed to the concept of maintaining the euro that they cave at these threats.  My bet is that even if Cyprus had tried an exit, it would quickly have come crawling back, an event that would have greatly strengthened the euro.

Well, at least this one wasn't a blank check.  The question is whether there was sufficient requirement of risk bearing to avoid providing the incentives for a bigger crisis the next time. 

New Greek Debt Deal: Why Again Is This A Good Idea?

Big news:  the Euro parties have reached yet another kind of sort of semi bailout deal for Greece, enough to avoid immediate default and calm the markets for  -- how long this time?  A few months?

Here is a report from the Wall Street Journal on the terms of the deal and reaction from various quarters.  The details ($51.7 billion of new money unlikely ever to be repaid; new "austerity" measures that Greece "really, really" promises to put into effect this time; a discounted exchange offer for certain outstanding Greek debt) are unimportant.  Supposedly, it's all about meeting some debt-to-GDP target in 2020.  Does anyone believe that that is real?  (By the way, these debt-to-GDP numbers are of the fraudulent cash in cash out variety, when of course the government of Greece is mostly in the pension/insurance business and has real liability numbers that are a large multiple of the published numbers and almost impossible to find.  See the previous post.)

But why are they doing this?  Is anything about it a good idea?  This is another one of those issues on which the conventional wisdom is completely unanimous and my view is just 180 degrees different.  And I think that my view is just so obviously, glaringly right that I can't even think of the counterargument.

The conventional wisdom:  The various Euro parties (Eurozone countries, ECB, IMF) need to do what is necessary to bail out Greece sufficient to avoid crisis and save the Euro.

My view:  The worst possible thing that the Euro parties can do is continue to provide tide-over bailouts to Greece and other irresponsible Euro countries.  This course of action only prolongs the crisis and makes each round of it worse than the previous one, while multiplying the cost for the paying parties and rewarding the bad actors in the irresponsible countries.  The best thing that could possibly happen would be for the other Euro parties to make a clear statement to the irresponsible parties that bailouts of any sort are not on the table, and you are welcome to stay or leave as you choose.

My starting proposition:  A sovereign who issues fiat currency and has the ability to borrow and pay his debts in his own fiat currency, will eventually (and in all likelihood, quickly) debase and destroy that currency and steal substantially all the wealth of the population.

Discussions of the economic success of the United States rarely even notice an aspect of the design of our Federal system that was probably unintentional but I believe of tremendous importance.  Namely:  the large majority of the functions of government were to be carried out by the states, but the control of the currency rested with the Federal government.  Thus, the main functions of government were provided by entities with no ability to issue their own currency, or borrow in their own currency. 

It didn't take very long for the states to try to behave irresponsibly.  Many of them overborrowed in the 1830s, and defaulted in the early 1840s.  The Federal government did not bail them out; did not even seriously consider it.  The states could only extricate themselves by getting spending under control and doing consensual deals with creditors.  They learned their lessons; many passed restrictions on incurring debt and balanced budget amendments.  And thus we had a settlement that made largely impossible the great plague of human history, that the sovereign overborrows and then debases and destroys the currency and with it the accumulated wealth of the population. 

That has worked extremely well all the way into my lifetime.  Today, it appears that the lessons of history have been forgotten.  At the state level, many politicians have figured out that they can evade debt restrictions and incur very long term debts in the form of pensions that are not recorded on balance sheets, whose magnitude can be effectively hidden from most voters, and that can be used to buy votes and political contributions from concentrated blocs of public employees.  The promises are far along toward bankrupting many of the states, but the politicians who put the promises in place will be long gone when the promises come due.

Meanwhile at the Federal level, the Federal government is no longer a small part of total government spending, but more like two-thirds of the total.  Constraints on printing money, mainly the so-called gold standard, were gradually weakened and then finally eliminated by the 1970s.  The "independence" of the Federal Reserve, never strong to begin with, has diminished into nothing.  And, of course, spending is exploding at Ponzi scheme growth rates.  Watch out!

So Europe, again without even seeming to notice that this was the essential benefit of the structure, set up a U.S.-like monetary system with the currency-issuer not controlled by any sovereign, and the sovereign countries giving up the right to issue their own currency and thus likely to be forced quickly into default and spending constraints if they behaved irresponsibly.  Within not too many years, a number of the participants behave irresponsibly, and the structure works exactly as it should, backing the irresponsible spenders right into a corner.

And the conventional wisdom unanimously agrees on the right thing to do:  Bail them out, bail them out, and bail them out again.  In other words, give the lowest common denominator sovereigns the ability to force the debasement of everyone's currency for the benefit of their own favored cronies.

So the history is:  On the one hand example after example of sovereigns who debased their currencies and destroyed the wealth of their citizens.  On the other hand, the sole example, as far as I know, of the United States, where a structural inability of the sovereigns to borrow in their own currency led to an initial sharp contraction, then a quick recovery, followed by nearly two centuries of economic boom. unprecedented in human history.  Which do you choose?  Perhaps the first may  seem to make sense if you believe that it is the government's moral duty to take on all downside economic risk to all citizens.