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The Spectre of Default in Europe

Default, Debt Renegotiation and Exit

When the Eurozone crisis burst out in early 2010, an RMF report identified three strategic options for peripheral countries, namely, first, austerity imposed by the core and transferring the costs of adjustment onto society at large, second, broad structural reform of the Eurozone in favour of labour and, third, exit from the Eurozone accompanied by default thus shifting the social balance in favour of labour.1  Not surprisingly, the preferred policy of Eurozone governments — at the behest of the IMF — has been austerity.  There has also been some reform, all of which has been in a neoliberal direction, as was discussed in chapters 3 and 4.  This course of action is consistent with the nature of the Eurozone and the entrenched neoliberal ideology at its core.  And nor is it surprising that the second option has found little favour, either in official discussions or in policy-making.  The nature of the crisis has required immediate measures leaving little room for long-term reforming initiatives, quite apart from the inherent difficulty of reforming the Eurozone in favour of labour.  Indeed, the Eurozone has become even more conservative during this period.

Nevertheless, as the policy of austerity has spread, the idea of default on public debt has also made significant headway.  Austerity is a highly fraught path for the economies of both periphery and core, as was shown in chapter 4, which might even worsen the problem of indebtedness.  In the global financial markets it is widely expected that Greece, at least, will face default in the future.  Voices have been heard within the mainstream claiming that austerity might be a dead-end, particularly for Greece, and thus favouring controlled restructuring of public debt.2  At the radical end of the political spectrum in Greece and elsewhere there have also been calls for default.  It is probable that even governments have considered the possibility, though in hermetically sealed rooms.

The concluding chapter of this report tackles default and debt renegotiation in view of the preceding analysis.  Since default inevitably raises the issue of Eurozone membership, the possibility of exit by peripheral countries is also considered.  The focus of discussion lies on the political economy of these options, all of which involve complex social changes and different sets of winners and losers, both domestically and internationally.  It is not easy to ascertain what is in the interests of working people in the periphery, not to mention the core.  The approach adopted here is that, if the path of default, renegotiation and exit was entered, it should lead to a change in the social balance in favour of labour.  By the same token, it should break the grip of conservatism and neoliberalism on the Eurozone.

Discussion below is conducted under the rubrics of creditor-led and debtor-led default.  Distinguishing between the two is useful in order to ascertain the social interests involved in default, renegotiation and exit.  Creditor-led default is likely to be a conservative policy path that would still impose the costs of adjustment onto working people, while leaving unchanged the underlying nature of the Eurozone.  Debtor-led default, in contrast, could bring significant benefits to peripheral countries, while creating room to shift the social balance in favour of labour.  Debtor-led default would immediately pose the question of exit from the Eurozone, thus inviting analysis of the implications for economy and society.

Default, renegotiation and exit are discussed below mostly as they would apply to a single peripheral country.  It is natural to make this assumption, given that the pressures of crisis have been overwhelmingly heavier in Greece compared to other peripheral countries.  Greece has been at the sharp end of the Eurozone crisis, and is likely to remain in that position for the foreseeable future.  But even for analytical purposes alone, it would still have been necessary to make the assumption that default, renegotiation and exit occurred in a single country.  Only then could the balance of social forces, the levers of economic policy and the international economic context be taken as given with any degree of precision.

Needless to say, if these decisive events occurred in one peripheral country, there would be major repercussions on the rest of the Eurozone.  For one thing, what holds individually for Greece, also holds individually for Spain and Portugal (and probably for Ireland, though it has not been considered in this report).  There are significant differences among the three, as was established in the body of this report, but their predicament as peripheral countries of the Eurozone is similar.  If one was to adopt default, renegotiation, and exit, the demonstration effect on the others would be great.  Each would naturally approach the issue from the perspective of its own social, political and institutional outlook, but the underlying economic compulsion would be similar.  The tale might be told primarily for Greece, but Spain and Portugal will also recognise themselves.

It should finally be mentioned that default, renegotiation and exit could, at the limit, lead to fracturing, or even collapse, of the Eurozone as a whole.  It is impossible to analyse with any credibility the repercussions of such a cataclysmic event, other than to state that the costs for both periphery and core would be great.  Yet, even this outcome would ultimately be the result of the nature of the Eurozone — exploitative, unequal, and badly put together.  The fault would not lie with peripheral countries but with the monetary union as a whole, which has placed the periphery in an impossible situation.  Working people in peripheral countries have no obligation to accept austerity for the indefinite future in order to rescue the Eurozone.  Moreover, if the Eurozone collapsed under the weight of its own sins, the opportunity would arise to put relations among the people of Europe on a different basis.  Solidarity and equality among European people are certainly possible, but they require grassroots initiatives.  The Eurozone in its present form is a barrier to this development.

Creditor-led Default:
Reinforcing the Straightjacket of the Eurozone

Austerity is a highly risky strategy when dealing with public debt because it restricts economic activity, as was shown in chapter 4.  Even official projections expect the ratio of public debt to GDP to continue rising in all peripheral countries until 2012-3, reaching 149% in Greece.  The dynamic of debt could become unsustainable, if there was a deeper than expected domestic recession, if social and political unrest occurred on a large scale, or if the European and the world economies took a turn for the worse.  The pressures would be greatest in Greece because of the extent of austerity measures and the volume of public debt; but the danger would be present for all peripheral countries.

If it became clear that austerity had begun to fail in Greece — and elsewhere — the prospect of creditor-led debt restructuring would raise its head.  Creditor-led default would not necessarily involve a unilateral suspension of interest payments, and formal default might not be declared.  Nonetheless, a controlled form of default could occur in practice, involving the exchange of old for new debt, perhaps along the lines of Argentina in the period immediately before its final default, discussed in Appendix A.  This process would obviously take place under the aegis of banks and within the framework of the Eurozone.  It would mean, at best, a mild “haircut” for lenders accompanied by a lengthening of maturities and possibly lower interest rates.  The banks that organised such a restructuring could expect to earn substantial fees.

Creditor-led default would be in the interests of lenders, particularly banks.  It should be stressed that this includes domestic lenders, for instance, domestic banks that hold significant volumes of public debt.  Lenders would benefit because the institutional mechanisms of the Eurozone would be brought to bear on borrowing states with the aim of minimising lender losses.  Banks would also benefit since they would continue to have access to ECB liquidity, in effect using the mechanisms of the ECB to facilitate the default.  Above all, lender banks would benefit by accepting the already-known fact that some of the public debt on their books was bad, subsequently shifting it off the balance sheet on favourable terms.  In that context, domestic banks would also attempt to swap old for new public debt on terms that transferred onto the state as much of the cost as possible.

Is it conceivable that creditor-controlled default could occur together with radical reform of the Eurozone?  Some political circles in Greece are still hoping for an associational approach to the problem of debt, the countries of the core offering genuine support to the countries of the periphery.  Could there be action that decisively lightened the burden of debt on the borrowers within the framework of the Eurozone, while also allowing for fiscal transfers from rich to poor, a larger European budget, wage protection, and so on?

The enormous difficulties of reforming the Eurozone in a pro-labour direction have been made clear in the course of the current crisis.  Default and debt renegotiation have pressing urgency, requiring counter-measures of equal urgency.  The Eurozone has introduced a rescue package at the cost of austerity, first in Greece but then across much of the rest of the union.  Faced with turmoil, it has opted for more pressure on working people, greater fiscal rigidity and punitive terms imposed on indebted countries.  At the same time, it has taken strong steps to rescue banks.  These actions are consistent with the nature of the euro as world money serving primarily the interests of financial capital in Europe.  The actions are also consistent with entrenched neoliberalism at the heart of the Eurozone.  This is not a system that would admit of pro-labour reform within the timescale of a debt crisis, if at all.

In sum, creditor-controlled restructuring of debt within the framework of the Eurozone is a conservative approach that would be consistent with the current policy of austerity.  For this reason, it is unlikely to prove a long-term solution for the crisis, and nor to bring significant benefits to working people in peripheral countries.  The burden of debt would remain substantial and austerity policies would probably continue.  The long-term outlook for Greece and other peripheral countries would remain poor.

Debtor-led Default and the Feasibility of Exit from the Eurozone

Debtor-led default is potentially a more radical option, though its outcomes would vary depending on how it took place.  If, for instance, austerity failed and creditor-led restructuring did not produce decisive results, the option of debtor-led default would emerge even for the current crop of peripheral governments.  But the prospect would then arise in the midst of social and economic chaos caused by failed austerity.  Thus, the deeper danger of the current policies of the EU and the IMF is that they might lead to a repetition of the experience of Argentina, discussed in Appendix A.  From this perspective, if peripheral countries were to adopt debtor-led default, they ought to do so on their own accord, decisively, in good time, and while setting in train profound social changes.

Debtor-led default would mean, in the first instance, unilateral suspension of payments.  The latter would usher in a period of intensified domestic social struggle as well as major tensions in international relations.  Thus, the country would have to decide which among its foreign obligations to honour, and in what order.  Even more complexly, domestic banks, institutional investors, and other holders of public debt would seek to protect their own interests.

From the perspective of working people, but also of society as a whole, it is imperative that there should be a public audit of debt following suspension of payments.  Transparency is a vital demand in view of the cloak of secrecy that envelops government borrowing.  Auditing the debt would allow society to know what is owed to whom as well as the terms on which debt contracts were struck.  It would also show whether parts of the debt were “odious” or illegal, allowing the debtor to refuse to honour such debts outright.  The future direction of default and its ability to produce benefits for working people would depend on whether transparency prevailed regarding the stock of debt.  This would be prime terrain of internal social struggle once default materialised.

Negotiations to settle the debt would follow at the initiative of the debtor, with a view to being concluded as rapidly as possible.  The objective of the enterprise could only be to achieve a deep “haircut” for lenders, thus lifting the crushing weight of debt on borrowing countries.  It is impossible to ascertain the extent of the “haircut” in advance and prior to auditing the debt but, for Greece, it is unlikely to be less than for Russia or Argentina, some details of which are given in Appendix A.  Two thirds of Greek public debt is held abroad, while the rest is held domestically.  The largest holders, both domestically and abroad, are banks.  Note further that the great bulk of public bonds appear to have been issued under Greek law, thus possibly allowing the country to avoid extended legal wrangles in US and UK courts, as would have happened for other middle income countries.3  Given that core banks are substantially exposed to Greece (and even more heavily to the periphery) as was shown in chapter 2, there are some advantages to Greece in renegotiating its public debt.  A government that reflected popular will and acted decisively might be able to secure deep “haircuts” in a fairly short order of time.

But debtor-led default would also carry significant risks.  The most immediate risk would be that of becoming cut off from capital markets for a period.  More complexly, default might lead to trade credit becoming scarce as international and domestic banks would be affected, thus hurting the debtor’s exports.  Even more seriously, default would run the risk of precipitating a banking crisis, since substantial volumes of public debt are held by both domestic and foreign banks.

International experience shows that the period of being cut off from capital markets does not last long, and there are always alternative sources of funding.  Typically, countries regain credibility within a short space of time, and capital markets exhibit a very short memory.  The threat to trade credit, on the other hand, would probably be of greater consequence, and the government would have to intervene to guarantee trade debts.  But the gravest danger would be posed by the threat of banking crisis, which could greatly magnify the shock of default.  To avert a banking crisis, there would have to be extensive and decisive government intervention.  In Greece this would certainly mean extending public ownership and control over banks, thus protecting the banks from collapse and preventing depositor runs.  Under public ownership, the banks could act as levers for root and branch transformation of the economy in favour of labour.

Could such a drastic course of action occur within the confines of the Eurozone?  Note first that it is entirely unclear whether it would be formally feasible.  No precedents of sovereign default exist within the Eurozone, and its legal framework makes no allowance for such an event.4  There is no firm way of ascertaining the formal response of the Eurozone to a unilateral suspension of debt payments by one or more of its members.  And nor is it clear what default would mean in terms of participating in the decision-making mechanisms of the Eurozone, including the setting of interest rates.  It is inevitable that the defaulter would become a pariah, but the formal outlook remains unclear.

Formal feasibility aside, would it be desirable for debtor-led default to occur within the confines of the Eurozone?  The answer is in the negative.  First, it would be more difficult for the defaulting country to confront a domestic banking crisis without full command over monetary policy.  More broadly, if banks were placed under public ownership following default but continued to remain within the Eurosystem, it would be practically impossible to deploy them in order to reshape the economy.  Second, continued membership of the Eurozone would offer little benefit to the defaulter in terms of accessing capital markets, or lowering the costs of borrowing.  Third, the option of devaluation would be impossible, thus removing a vital component of recovery.  The accumulation of peripheral country debt is inextricably tied to the common currency and as long as the defaulter remained within the Eurozone the problem would reappear.

Consequently, debtor-led default raises the prospect of exit from the Eurozone.  Exit would offer immediate control over domestic fiscal and monetary policy.  It would also remove the constraints of a monetary system that has resulted in embedded current account deficits for the periphery.  It is reasonable to expect that devaluation would allow for recovery of competitiveness.  It is also plausible that there would be a rebalancing of resources in favour of domestic industry.  The outcome would be protection of employment as well as lifting the pressures of austerity on wages.  As can be seen for Argentina and Russia in Appendix A, default and devaluation resulted in rapid recovery.  To be sure, peripheral European economies are different from these resource-rich, primary commodities exporters.  But there is no reason to expect that other areas of activity, such as tourism and parts of the secondary sector, would not respond positively to devaluation.

But exit would also entail costs, given the violent change of monetary system.  The return to a national currency for Greece, or another peripheral country, would be more difficult than the “pesification” of the Argentine economy, given the unprecedented degree of monetary integration within the Eurozone.  However, replacing the euro is not a complex policy, and its basic parameters are not hard to ascertain.  The decision would have to be announced suddenly in order to minimise capital flight; there would be an extended bank holiday; banks would be instructed to convert deposits and other domestic liabilities and assets into the new currency at a nationally chosen rate.  When banks reopened, there would be parallel domestic circulation of the euro and the new currency, resulting in twin prices for a range of goods and services.  There would also be monetary unrest as contracts and fixed obligations adjusted to the new unit of account.  To prevent collapse of confidence, which could have catastrophic effects for economic activity, there must not be dithering once the policy has been adopted.  Eventually prices and monetary circulation would adjust to the new currency, while the euro would be excluded from the domestic economy.

The international value of the new currency would inevitably fall, creating complex movements in the balance of domestic social forces.  Banks and enterprises servicing debt abroad would face major difficulties; their immediate response would be to try to shift some of their own debt onto the state.  On the other hand, those holding assets abroad would seek to speculate against the new currency.  For the domestic capitalist class, the return to a national currency would represent an opportunity to transfer costs onto society, while attempting to obtain a transfer of wealth as the new currency devalued.

From the perspective of working people, but also of society as a whole, the answer would be a broad programme of public ownership and control over the economy, starting with the financial system.  Public ownership over banks would guarantee their continuing existence, preventing a run on deposits.  Capital and foreign exchange controls would also be imposed to prevent export of capital and to minimise speculative transactions.  A set of conditions would thus be created allowing for the adoption of industrial policy which would alter the balance of the domestic economy by strengthening the productive sector.  The sources of growth in the medium term would be found in the decisive restructuring of the economy, rather than the expansion of exports through devaluation.

The new currency would also create inflationary pressures as import prices would surge, particularly energy prices; real wages would fall as a result.  Confronting these pressures would be far from easy, but certainly feasible.  It is, first of all, impossible to tell what would be the pass-through from import prices to domestic prices.  Furthermore, renewed command over monetary policy would allow for counter-inflationary measures, particularly during the months of the initial shock of devaluation.  Support for real wages could then be provided through a policy of income redistribution effected through taxing higher incomes and wealth.  After all, peripheral countries are the most unequal in the Eurozone and in urgent need of redistribution.  Note further that a bout of inflation would reduce the vast burden of domestic debt.

Default and exit, finally, would create problems of public finance, particularly as access to the international funds would come to an end.  International experience shows that the primary balance typically returns to surpluses soon after an event of this nature has occurred.  In the short term, public finance problems would be ameliorated as recovery began after default.  The government could also borrow from the nationalised banking system as well as monetising the deficit to a certain extent.  But for a country such as Greece, the medium term answer must be to restructure the tax system by expanding the tax base to include the rich and capital itself.  This would be an integral part of restructuring the Greek state as a whole, making it more democratic and accountable.  There could be no permanent resolution to public finance problems in Greece, or other peripheral countries, unless there was a change in the nature of the state, reflecting an underlying shift in the balance of class forces.  More broadly, there could be no rebalancing of the economy in favour of working people without a profound restructuring of the state.

In sum, there are no easy alternatives for working people in peripheral Eurozone countries.  The dilemma faced by these countries is harsh.  They could acquiesce to austerity, remaining within the Eurozone and putting up with recession, or stagnation, for the indefinite future.  Alternatively, they could opt for debtor-led default accompanied by exit from the Eurozone.  The latter option could signal a radical transformation of economy and society, shifting the balance of power against capital.  The distributional struggle over who would carry the costs of the crisis would continue, but more favourable conditions would have been created within which to fight for a progressive solution in the interests of the many.  Debtor-led default could prove the start of an anti-capitalist turn across the periphery of the Eurozone that would lift the neoliberal stranglehold over the EU, thus jolting Europe in an associational, socialist direction.  It remains to be seen whether European workers in the periphery but also the core have enough organisational and ideological strength to bring about such profound change.


1  See RMF report, “Eurozone Crisis: Beggar Thyself and Thy Neighbour”, March 2010, chapter 7, pp. 49-59.

2  See Roubini, N., “Greece’s Best Option Is an Orderly Default”, Financial Times, 28 June 2010; or Beattie, A., “Why Greece Should Default”, lecture delivered at the LSE, 14 July 2010.  Podcast available at: <

3  See Buchheit, L. and Gulati G. Mitu, “How to Restructure Greek Debt”, 2010.

4  See Athanassiou, P., “Withdrawal and Expulsion from the EU and EMU: Some Reflections”, European Central Bank, Eurosystem, Legal Working Paper Series, No. 10, December 2009.  Athanassiou thinks that exit from the Eurozone would be ‘inconceivable’ without also exiting the EU.  Suffice it to note that what is inconceivable to lawyers at one point in time could become eminently conceivable at another.

The text above is the concluding chapter of C. Lapavitsas, A. Kaltenbrunner, G. Lambrinidis, D. Lindo, J. Meadway, J. Michell, J.P. Painceira, E. Pires, J. Powell, A. Stenfors, and N. Teles, “The Eurozone between Austerity and Default” (Research on Money and Finance, September 2010); it is reproduced here for non-profit educational purposes.  See, also, Andrew F. Cooper and Bessma Momani, “Negotiating Out of Argentina’s Financial Crisis: Segmenting the International Creditors” (New Political Economy 10.3, September 2005); Eric Helleiner, “The Strange Story of Bush and the Argentine Debt Crisis” (Third World Quarterly 26.6, December 2005); Eduardo Levy-Yeyati and Ugo Panizza, “The Elusive Costs of Sovereign Defaults” (Inter-American Development Bank Research Department Working Paper #581, November 2006); Samir Amin, “Managing the Euro: Mission Impossible!” (MRZine, 17 June 2010); Luiz Carlos Bresser-Pereira, “Greek Debt: Default or Restructuring?” (MRZine, 10 July 2010); Yanis Varoufakis, “A Modest Proposal for Overcoming the Euro Crisis” (MRZine, 5 November 2010): Tracy Alloway, “Who’s Bailing Out Whom?” (FT Alphaville, 18 November 2010); Landon Thomas Jr., “In European Debt Crisis, Some Call Default Better Option” (New York Times. 22 November 2010); Bob Davis, “Amid Irish Aid, a New Option: Some Critics of Latest Bailout Propose Sovereign Default to Keep Debt in Check” (Wall Street Journal, 23 November 2010).

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