Monday, May 23, 2011

Where will the disgrace of defaulting be laid in Euroland?

In the past, countries defaulting on their debt obligations have tended to bear the brunt of the blame in increased borrowing costs in the decades that follow the default.

The assumption during the present crisis seems to have mainly been that this will be true for the ex-nations that may be forced to default due to their inappropriate membership of the Euro Group. I wonder if that will be true? As it is the ECB and the triple 'A' rated Euro Group members who are driving the brutal and dreadfully misplaced policies that are clearly only worsening the plight of the periphery members, surely the eventual consequences will fall most heavily upon them?

As Default is now a matter of how rather than when, read this analysis from September last year, which appeared on the site of titled "Ask not Whether Governments will Default, but How", linked here, from which I quote the following:

It is not whether to default, but how, and vis-à-vis whom. What this means is that - as indicated above - governments will impose a loss on some of their stakeholders and have in fact started to do so (across Europe at least). The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take. From the perspective of sovereign debt holders, this translates in two questions:

  • Does their claim on governments rank senior enough relative to other claims to fully shelter them from losses?
  • If it does not, what form will this loss take?

Bonds remain the most senior government liability. There are good reasons why government bonds should rank senior to most other liabilities. To mention one: governments need to be able to raise finance to fund public investment as well as to perform their macroeconomic stabilisation role. They cannot issue equity, and cannot credibly issue secured debt. Unrestricted access to unsecured, confidence-based funding is core to their 'business model', as it is for banks. This was, historically at least, the main argument for honouring sovereign debt. There are others, not least the consequences of a government default for output and for financial stability when banks own substantial exposure to the sovereign.

In the Eurozone, it is now the ECB and the still liquid taxpayers who will be stuck with the costs of the imminent peripheral defaults.

In the UK other stakeholders will have to be found to take the hit. My posting on "Orphans of Liberty" over the weekend, titled 'The NHS can cure the country' sparked some debate, but charging for health care seems an obvious next step given the dire straits and deep incompetence of our country's rulers. The stakeholders in the UK are the taxpayers, and while banks and bondholders are to be protected it has to be at the expense of taxpayers or beneficiaries of Government spending, namely public pensions, health, welfare etc., defence by now having already been cut almost to the bone.

Huge and real cost savings can better be made, were our Government not scared witless at taking the role of the small boy in the crowd in Hans Christian Andersen's fairy tale, and pointing out to the EU, its increasingly obscene nakedness.

Refusing further money transfers until the EU ceases to operate beyond the intent and legality of the EU Treaties, would seem a perfectly reasonable and legally justified attitude to take.  Worse, given the French Finance Minister's admission that Ecofin has been acting illegally over the EFSF, backing that same lady, Mme Christine Lagarde, for the post of Managing Director of the IMF, as George Osborne did at the weekend, shows not merely our complete insanity, but also our groveling subservience to the deeply flawed and clearly failing EU!

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