Query. If Greece were to default on its sovereign euro-denominated debt, I understand the massive disruptions and disasters that could cause in so many ways, ranging from hits to the banks holding the debt, to so many other things. What I am not sure I understand is how a sovereign default of euro-denominated Greek government bonds threatens the euro as such. Does it? If so, how exactly? I’m not covertly urging any policy here, I’m just trying to understand if it is the case.
If investors had treated the euro only as a currency, in which member countries still stood on their own fiscal bottoms at risk of default, then they would presumably have continued to differentiate Greek government debt from German in risk premiums demanded. Not having done so, the possibility of Greek default looms (not at this very moment, to be sure), but after the horrible (I don’t mean to downplay how horrible, but still want to focus on the monetary question) stuff happens, then Greece goes back to a Greek risk premium, whether it issues its debt in drachmas, dollars, euros, or anything else? The Greek government tries to sell bonds; it does not print euros.
The Financial Times has an op ed today urging the sensible policy that the eurozone needs to prepare today for the possibility of default on sovereign euro debt. That editorial assumes that it is possible to separate out the fiscal decisions of governments from the monetary decisions of the ECB. That being so, there are two general approaches, it points out, to a sovereign default process, based on what has been proposed, though not accomplished, in developing world settings:
Two approaches to designing a restructuring regime were debated after the last round of sovereign defaults a decade ago. One is a statutory framework, overseen by a supranational body, for modifying the rights of creditors. This was the idea behind the International Monetary Fund’s ill-fated Sovereign Debt Restructuring Mechanism. The second is to insert “collective action clauses” into sovereign bond contracts to make recalcitrant creditors agree to a negotiated restructuring. But these ideas were tailored to emerging countries, whose debt is generally issued in foreign jurisdictions and currencies. Most eurozone sovereign debt is domestic … That means a eurozone restructuring regime would face an immense challenge. Much legal groundwork would be needed to make such a regime comply with national laws, and the political will would have to be found to establish it.
I seem to recall, without looking back for it, that many commentators in the first debates over a looming Greek default saw default on euro obligations, at least by eurozone governments, as something that must inevitably topple the currency zone itself. The collateral damage of course might. But unless I am missing something obvious, it does not seem to be a foregone consequence, a logical consequence of currency union itself. It portends, rather, a looser eurozone in which a currency is shared but in which creditors sharply distinguish between issuers of debt and their conditions, including as sovereigns. It might be baked into the politics of the zone that countries must be bailed out; it does not seem to be baked into the very idea of a “currency.”
Or am I missing something really obvious? Such as, maybe, the inflationary possibilities created by a country able to sell euro debt in whatever quantities it can get the market to buy? But of course zillions of countries issue dollar denominated debt, and that is separate from whatever the US government, Fed or Treasury, does as a matter of monetary policy. I keep thinking I am forgetting something very obvious, however, so if I am, please explain it to me.
Update: For example, apart from the ability of a sovereign government to issue its debt in euros – which anyone in the world might do, of course – might a Greek default on its euro denominated sovereign debt impact the monetary use of the euro in its domestic economy in some crucial way? Countries in the euro zone cannot unilaterally devalue; prices nonetheless adjust. In price adjustments, are there ways in which drastically large differences, induced by default or other stress, might result in arbitrage of goods or services between Greece and the rest of the eurozone, in ways that would threaten the euro as such? In other words, I’m trying to see if there are genuinely monetary consequences that inevitably attach to fiscal policies, including fiscal failure, taken by governments that nonetheless do not have access to monetary tools directly.