Presenting a… revisionist view of why the European Central Bank president hates any Greek debt restructuring, in whatever form.
One in which the stakes get a lot higher too.
Here’s a chart where, basically, Europe tips inexorably to fiscal union when the lines cross — and President Trichet knows it:
The chart comes via David Mackie, economist at JPMorgan, who’s pointed out before that the eurozone is by this point going to find a one-off fiscal transfer to Greece — in less technical terms, taxpayer money that will never be got back– effectively unavoidable. In other words, Greece’s obligations to official creditors will outweigh its private debt burden very soon, especially if there is a second round of loans. The more so, loans with no private restructuring.
Effectively, the official sector will bear the brunt of writing down Greece’s debt, extending it to infinity, whatever. This is what the above chart is on about as well, although it includes ECB holdings of private Greek bonds. But even if you exclude the ECB, the time is approaching when Greece flips to being a net official debtor, unless ways are found to bail-in private creditors.
Unless, of course, you actually want to force Greece into becoming this net official debtor, and thereby force Europe to decide what to do with the fiscal transfer issue that’s created.
So how’s this for a brilliant joining of the dots by Mackie:
President Trichet’s vision of the future of the Euro area does not have any role for debt restructuring as the ultimate sanction on a Euro area sovereign that fails to deliver debt sustainability over time. Instead, Trichet wants to reinvigorate the forward momentum that the region has lost in recent years toward an ever closer union. If the ECB is successful in its attempt to prevent any kind of debt restructuring in the near term, the region will indeed move down the path towards the destination that Trichet wants it to go to. If Greece’s gross financing need—its deficit and amortizing market debt—continues to be met by official support, then it won’t be long before its official liabilities exceed its outstanding market debt. At that point, debt restructuring will no longer be an effective sanction and the region will have to deal directly with the issue of fiscal sovereignty.
It’s logical, isn’t it? But not therefore sound.
This is not the only reason the ECB hates Greece restructuring, given its bond-buying and collateral exposures. But it is cogent in the context of Trichet’s recent, odd, call for a common eurozone financial ministry to surveil, and presumably penalise, national governments that run high deficits.
Odd, for this reason. Trichet expressed a fulsome desire for the ministry to have ‘a much deeper and authoritative say in the formation of the [naughty] country’s economic policies’, but had nothing to say about a centralised budget (there is a EU budget, although it’s pathetic) or issuing eurozone bonds. In fact he was arguing for the one thing guaranteed to inflame objections that eurozone fiscal union will be anti-democratic, by pushing for an intrusive surveillance process. It’s also not very pragmatic: all previous attempts at surveillance have failed.
Above all, there’s something about the old “exit, voice, loyalty” heuristic that political scientist Albert Hirschmann used to use. Loyalty is expensive, and voice is being reduced by the role of surveillance, so the periphery might as well just plump for exit. Stalling a Greek restructuring in a bid to lock in fiscal union may simply backfire.
Spectacularly.
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Alexander Hamilton and the eurozone
Oh and one other thing. Trichet is forgetting that the runaway success in fiscal unions of the last 200 years got started with a sovereign debt restructuring. Indulge this bit of FT Alphaville historical musing, if you please.
Because we all remember what Alexander Hamilton did for the young United States of America in 1790, don’t we?
Basically, northern US states had issued debt to fight the war against the British, but quickly went bust in a recession after. Fiscally-correct southern states refused to bail them out. (Yeah, geographically upside-down but very familiar, isn’t it?) Northern bonds collapsed in price in the meantime, directly affecting members of the public who had bought them at face value.
It was getting to one side of the other seceding or even the Union crashing towards disorderly default, when Hamilton rocked in and came up with a plan. A debt assumption plan — the First Report on Public Credit — which effectively restructured state bonds as the price for fiscal union and ultimately, the USA’s status as the world’s safest sovereign credit. If you’ve ever read the Federalist Papers (really, who hasn’t?) you’ll know Hamilton had long seen a robust public debt as the anchor for a strong economy.
The federal government would assume the debt and issue bonds to cover them, but would only pay off interest, not the outstanding principal. It’s possible to argue whether this was really a sovereign default, we suppose, but FT Alphaville reckons that if there had been ye olde credit default swaps at the time, they would have triggered. And seriously, the southern states managed to get the federal capital sited in their territory into the bargain:
The credit event that built Washington DC. Kind of an intriguing, slightly bizarre perspective on current US debt ceiling politics as well, really.
The important thing is that the formula was common finance ministry + common bonds + judicious debt restructuring. Mr Trichet would have it the wrong way round. In fact US states’ requirements to give up fiscal sovereignty and balance budgets appeared much later, during the 1800s.
So even if Trichet is countering a Greek default as a last-ditch, clandestine route to fiscal unification, history isn’t backing him.
Update – Paul Krugman not so forgiving on Mr Trichet…
Related links:
Two deficits, two austerities, and quantities matter – Interfluidity
A modest proposal for overcoming the euro crisis - Levy Institute
Greece, Europe and Alexander Hamilton – NYT (2010)