Financial Times | One of the pillars upon which the euro was established was the principle of “no bail-out”. When the sovereign debt crisis hit the eurozone this principle was ditched. As Greece, Ireland and Portugal were unable to service their unsustainable levels of debt, a mechanism was instituted to supply them with the financing necessary to service their obligations. This financing was provided, supposedly, in exchange for their implementing measures that would make their, now higher, debt burdens sustainable in the future. Yet the mode adopted to resolve the debt problems of countries in peripheral Europe is, apparently, to increase their level of debt. A case in point is the €78bn ($116bn) loan to Portugal. It is equivalent to more than 47 per cent of its gross domestic product in 2010, possibly increasing Portugal’s public debt to about 120 per cent of GDP.It could be claimed that this mechanism is helping the countries involved since the official loans, although onerous, carry better conditions than the ones that need to be serviced. But the countries’ debts will increase (as a percentage of GDP the debts of Greece, Ireland, Portugal and Spain are expected to be higher by the end of 2012 than at the start of the crisis). The share of debt owed to the official sector will also increase (in addition to the bond purchases by the European Central Bank, which reportedly owns 17 per cent of these countries’ bonds with a much higher percentage held as collateral).
Is this ongoing piling of debt an indication of imminent defaults? Probably, but not necessarily. An immediate default could result in major market commotion, given the high exposure of European banks to peripheral debt. Therefore, European governments are finding it more convenient to postpone the day of reckoning and continue throwing money into the peripheral countries, rather than face domestic financial disruption. Consequently, as long as European and international money (through the International Monetary Fund’s generous financing) is available, the game could go on.
It is based on the fiction that this is just a temporary liquidity problem and that the official financing helps the countries involved to make the reforms that will allow them to return to the voluntary market in normal conditions. In other words, the narrative is that the recipient countries could and would outgrow their debt. To “prove” this scenario is feasible several debt sustainability exercises are being dreamt up. But the fact is that this situation is only sustainable as long as additional amounts of money are available to continue the pretence.
Here is where this situation resembles a pyramid or a Ponzi scheme. Some of the original bondholders are being paid with the official loans that also finance the remaining primary deficits. When it turns out that countries cannot meet the austerity and structural conditions imposed on them, and therefore cannot return to the voluntary market, these loans will eventually be rolled over and enhanced by eurozone members and international organisations. This is Greece, not Chad: does anyone imagine the IMF will stop disbursing loans if performance criteria are not met? Moreover, this “public sector Ponzi scheme” is more flexible than a private one. In a private scheme, the pyramid collapses when you cannot find enough new investors willing to hand over their money so old investors can be paid. But in a public scheme such as this, the Ponzi scheme could, in theory, go on for ever. As long as it is financed with public money, the peripheral countries’ debt could continue to grow without a hypothetical limit.
But could it, really? The constraint is not financial, but political. We are starting to observe public opposition to financing this Ponzi scheme in its current form, but it could still have quite a way to go. It is apparent that, if not forced sooner by politics, the inevitable default will only be allowed to take place when the vast part of the European distressed debt is transferred from the private to the official sector. As in a pyramid scheme, it will be the last holder of the “asset” that takes the full loss. In this case, it will be the taxpayer that foots the bill, rather than the original bondholders that made the wrong investment decisions.
