How do you leave the Euro? Plan C: odious debt...
I once used to frequent a very decent restaurant on Kefalonia where you could get lobster pasta for 1700 drachmas. In the summer of 2002 I was stunned to find, chalked on the very same board in the very same harbour, that lobster pasta was now to cost 17 euros. In fact the old zeros were still faintly visible, but not the drachma sign.
The final exchange rate of the Greek drachma was 340/1, making the pre-Euro lobster a notional 5 euros - so this was a > 3x increase. But on adoption of the Euro the restaurant had simply decided it had entered the north-European economy and would now charge north-European prices. I have to say, it was still worth it - but it was a shock.
Soon Greeks may experience a shock in the other direction.
For, with GDP shrinking by 4.5% last year, on track to shrink a further 3% this year and unemployment on track to hit 15%, it is not clear how Greece will avoid a deflationary spiral. With Ireland scrambling to renegotiate, money flying out of the Emerald Isle at an alarming rate - and Portugal (10 year bond yield currently 7.5%) about to go through the wringer of bailout pressure from the ECB, everyone is talking about a "Plan B".
Plan B is that these countries go cap in hand to the EU Summit on 24 March 2011 and demand a collective renegotiation of the terms of the bailout. This would then move the stress in the European finance system towards the core, with most probably an uptick in the interest rate on French and German debt. Possibly it would involve an element of debt restructuring, so far ruled out by the ECB for any debts incurred before 2013.
But some are now openly contemplating a "Plan C". Around the fringes of mainstream politics in the stricken countries are now quite significant leftist or quasi-leftist parties in parliament and they are beginning to link up with debt NGOs more normally associated with the developing world over the issue of so-called "odious" debt.
Once the term "odious debt" enters the conversation, it leads inexorably to the suggestion that the stricken countries - above all Greece - should default on their debts. That is, instead of waiting for some kind of controlled restructuring of debt under the aegis of the ECB/IMF, they take control of the process themselves and declare - as with Argentina in 2002 - a default (Argentine investors got about 30% of their money back over the decade).
The odious debt concept emerged in 1927 as a discussion in international law about what to do with debts contracted by one state with another, where the debtor state then experiences a revolution and decides the previous government were rotters who contracted the debt without benefiting their own population. There is a sporadic case law on the question, outlined in this UNCTAD research paper.
However the bad debt sinking the peripheral economies of Europe is not primarily state-to-state debt, but state-to-bank debt: so the "odiousness" is not really relevant. If you are going to default, then you default - for whatever reason - and get on with it.
In polite European society it is not done to talk about default: but the cost of insuring E10m of Greek five year debt against default is currently about E0.8m - that is, there a precisely measured likelihood of default understood by the markets and it's about 12-1 and "coming in" as they say at the bookies'.
Two weeks ago Greek labour minister Louka Katseli, a perennial grumbler about the austerity plan, is said to have made some remarks that I cannot track down in the English language press along the lines that Greece might have to form a committee of wise men to look at what to do about its debt. I will try and find the precise quote.
We are going to see all kinds of peripheral rumblings about odiousness, "studying the structure of debts", the potential haircuts, repayment delays etc: and these of course form the thin end of the wedge of a full-blown default debate.
Right now, EU governments are obliged to hold the line on the impossibility of Plan C.
Yet the markets keep reflecting its possibilty, by edging upwards the cost of insuring against default, and by removing money from the countries they deem to be at risk of default.
This influential post from the geo-economics team at the Council on Foreign Relations is worth quoting in full (and the graph is worth a look, too):
"In the midst of the financial crisis of 2008, governments helped to prevent bank runs by guaranteeing bank debts. Yet as sovereign solvency itself becomes an issue, such guarantees quickly lose their value. If Ireland provides a rule of thumb, bank runs can be expected once sovereign credit default swap yields pass 3%. The figure above shows that when Irish government CDS yields first passed 3% in early 2009, foreign deposits fled the country. This happened again in late 2010. Now that Spanish CDS yields have broken the 3% threshold, there is reason to be concerned about the stability of Spanish bank deposits as well." (Council on Foreign Relations blog, 5 January 2011)
To summarise: nobody in mainstream European politics wants to see any country leave the Euro. Yet the non-mainstream politics are getting bigger as the elections tick over, and the markets themselves are registering a growing possibility that one country will go through a controlled default. An uncontrolled default would send the stress straight through from the periphery to the core: it would hole several EU banks below the waterline - as pointed out in my previous post.
Then the countries of the EU's northern core would have to finally pay the price of a decade of misalignment, profligate lending, low competitiveiness and tax evasion they turned a blind eye to in southern Europe.