Should European Nations Repudiate the Debt?

L Randall Wray writing in New Economic Perspectives.  The answer to the question is YES…

Monday, June 13, 2011

Should European Nations Repudiate the Debt?

By L. Randall Wray

It is becoming increasingly clear that the global economy (at least in the West) is heading for a steep downturn. Almost all the US data coming out in recent days have been bad. The UK and Japan are in austerity mode, with predictable results. Worst of all is Euroland. It has imposed severe austerity—the modern day equivalent of Medieval blood-letting—on its periphery nations. These nations are loaded with debt. In the case of Ireland, which had been a model of a Neoliberal utopia, the government got into debt by taking over its banks’ debts. In an unfathomable act of charity, this was done only to save French and German banks—which held the unserviceable and unguaranteed Irish bank debt. In gratitude for Ireland’s equanimity, the EU imposed the equivalent of IMF sanctions on Ireland. The government is supposed to downsize and squeeze blood out of its population in order to reduce its debt load—which has thrown it into recession and reduced tax revenues. The worst thing you can do to a debtor is to force her to reduce her income. But that is exactly the Medieval medicine the EU prescribed for Ireland. The story with the other highly indebted euro nations is similar—if not in the causes of their particular debt disease, at least in the remedy prescribed. …

Randall Wray concludes…

Defaulting whilst staying on the euro appears to me to include all the negative effects of leaving the euro but with none of the benefits. For example, Ireland and the other periphery nations would still be stuck with a vastly overvalued currency. At least if they abandoned the euro they could competitively devalue against German exporters. They will get sued in either case and rulings in EU courts will probably go against them. Perhaps it is best to leave the EMU and even the EU to protect their domestic economies if one is going to default.

The last option is to band together and to insist on EMU-wide reformation. Debts must be restructured and written-down. To be sure, default as well as leaving the EMU must be retained as a bargaining chip—but it should be “en mass”. And it should be made clear that the best option for both the indebted nations as well as the creditors is to come to mutually beneficial terms. European banks are, broadly, toast. Not only did they buy toxic US waste, but they also created plenty of their own. And they owe much of it to each other. Like the biggest US banks, they are “too big to fail”—which is to say that they are “systemically dangerous institutions” in Bill Black’s terminology. That means they must be “resolved”—downsized and closed, with assets and liabilities distributed to smaller institutions. Netting bad assets that banks owe to each other (within and across borders) would go a long way to downsizing exposures. (And banksters should be incarcerated. I suspect that the main reason that big banks are not closed is because governments know they will uncover massive go-to-jail fraud. It is not really that the banks are too big to fail but rather that they are too fraudulent to seize. If any honest examiner ever entered the doors of Goldman Sachs, for example, he could not leave with issuing thousands of subpoenas that would include the names of former, current and prospective future Treasury department officials.)

It is time to admit that the EMU was designed to fail. I have been arguing since the mid 1990s that the first serious financial crisis would bring it down. We are in that crisis. It is time to recognize that reality. The debts must be resolved and a new fiscal arrangement must be created. As I have argued many times, the EMU members are like US states, but without a Washington to help out in times of crisis. The chickens are here and they are roosting. We have come down to one viable choice—if the goal is to preserve European union. In addition to dealing with the debt, the EU must create a fiscal force similar in size to the US Treasury.

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