The daunting (but not always insuperable) arithmetic of sovereign debt
Will Chancellor Angela Merkel of Germany have to take a call in the near future from Rome only to find out that Italy has followed Greece in defaulting on its sovereign obligations? And would she be so brave as to query,
“Et tu, Berlusconi?”
Key countries within Europe had sovereign debt as of the end of 2010 that exceeded 9.3 trillion euros, with 3.1 trillion euros accounted for by the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain), which are currently the focus of all discussions (see table). A few Scandinavian countries have debt that is equivalent to less than 60% of GDP, one of the supposed criteria for joining the euro, but even core countries such as Germany and France have ratios
Of course, Greece has not defaulted…yet. Not much time is left to figure out which countries can be fixed, and how. “Kicking the can down the road,” one phrase recently added to the financial lexicon, remains unsatisfactory to
investors, and is probably nearing the end of its shelf life for politicians, too.
The alternative preferred by some – blow everything up now and be done with it – is even less satisfactory. The arithmetic of sovereign debt is indeed daunting, but it is not always insuperable. In those cases where the arithmetic works, it makes sense to offer solutions that include government support and forbearance – in other words, when the arithmetic works, no matter how daunting, kick the can down the road.
And in those cases where the numbers areinsuperable, stop kicking the can and start down a new road.
This paper sets itself two tasks. The first is to construct a simple model that would arithmeticize the dynamics of sovereign debt so as not to get hung up with all of the acronyms and programs designed to save the world. The second
is to put this into the context of the European sovereign debt problem and hazard some opinions as to which options can work, and which cannot.
1. In a world of low growth, it would take a miracle for Greece to escape without negotiating a large cut in the principal of its debt;
2. It is, however, credible that defaults can be limited to a few small countries, and perhaps only to Greece, while the rest can string things along until a somewhat more normal global economic growth pattern resumes later this
3. The probable need to recapitalize commercial banks to cover defaults casts a long shadow on the process; and,
4. The eurozone is likely to need more resources than it has gathered so far, with the European Central Bank (ECB) printing more money probably the easiest way to find those resources. In other words, the arithmetic of Europe’s sovereign debt crisis is daunting, but not insuperable.
GMO White Paper Et Tu Berlusconi//