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Europe cannot default its way back to health

By Lorenzo Bini Smaghi (member of the Executive Board of the European Central Bank)

An oft-made assumption is that governments can renegotiate with their creditors the terms and conditions of their debt instruments without this having major repercussions on the rest of the economic and financial system. This assumption is largely based on the experience of developing countries with underdeveloped financial systems and mainly foreign creditors. What is generally not well understood is that, in advanced economies, public debt is the cornerstone of the financial system and an important component of the savings held by citizens.

As recent events have shown, the simple fear of a default or of a restructuring of public debt would endanger the soundness of the financial system, triggering capital flight. Without public support, the liabilities of the banking system would ultimately have to be restructured as well, as was done for example in Argentina with the corralito (freezing of bank accounts). This would lead to a further loss of confidence and make a run on the financial system more likely. Administrative control measures would have to be taken and restrictions imposed. All these actions would have a direct effect on the financial wealth of the country's households and businesses, producing a collapse of aggregate demand. Taxpayers, instead of having a smaller burden of public debt to bear, would end up with an even heavier one.

As opposed to what's happening now?


Many commentators fail to realise that the main impact of a country's default is not on foreign creditors, but on its own citizens, especially the most vulnerable ones. They would suffer the consequences most in terms of the value of their financial and real assets.

In which country do the most vulnerable citizens own financial or real assets?


The economic and social impact of such an event is difficult to predict. The democratic foundations of a country could be seriously threatened. Attentive observers will not fail to notice that sovereign defaults tend to occur in countries where democracy has rather shallow roots.

Europeans have not forgotten the devastating effects that the expropriation of wealth, such as that carried out during the two world wars by way of inflation or defaults, may have on the economic and social fabric.

Godwin! Godwin!


Wind power

by Jerome a Paris (etg@eurotrib.com) on Fri Dec 17th, 2010 at 11:55:16 AM EST
By Lorenzo Bini Smaghi (member of the Executive Board of the European Central Bank)

We're doomed.

Oh, and Godwin, Godwin indeed:

Migeru:

FT.com: Europe cannot default its way back to health by Lorenzo Bini Smaghi
Europeans have not forgotten the devastating effects that the expropriation of wealth, such as that carried out during the two world wars by way of inflation or defaults, may have on the economic and social fabric. There is awareness that, in the end, it may be less costly to tackle excessive public debt with the traditional remedies - that is, achieving an adequate level of primary surplus - rather than looking for quick fixes. There is also awareness that, without restoring economic growth, the debt burden cannot be reduced over time. This requires major structural reforms aimed at improving the functioning of the labour, capital and goods markets.

...

To understand what is happening in Europe, economics textbooks are useful but the history ones even more so.

The writer is a member of the Executive Board of the European Central Bank

(h/t Eurointelligence)
Apparently according to this guy the "devastation of the economic and social fabric of Europe" during the two world wars is associated by "Europeans" with "expropiation through inflation and default".

Mustard gas, trench warfare, carpet bombing and concentration camps have nothing to do with anything.

And the guy has the gall to appeal to history books!?

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010

by Migeru (migeru at eurotrib dot com) on Fri Dec 17th, 2010 at 12:01:49 PM EST
[ Parent ]
The elites are scared that the idea is catching on. Quick, peel more onions about the horrors of default

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Fri Dec 17th, 2010 at 12:06:12 PM EST
[ Parent ]
They're not peeling onions, they're smoking them.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Fri Dec 17th, 2010 at 12:08:33 PM EST
[ Parent ]
Bin Smaghi will say more things in this style. How else can he hope to beat (insert any German name here) for ECB chairman after Trichet?
by afew (afew(a in a circle)eurotrib_dot_com) on Fri Dec 17th, 2010 at 02:35:13 PM EST
[ Parent ]
Krugman: They Have Made a Desert
And called it successful adjustment. Matthew Yglesias marvels at European policy makers who consider Latvia a success story. And their satisfaction is indeed something wondrous to behold. Here's a comparison:

A few more such successes and Latvia will have no economy at all.
Iceland defaulted. What can Bini Smaghi say about this?

Yglesias: The Latvian Catastrophe

Klaus Regling, chief executive of the European Financial Stability Facility, wants you to know that monetary union without fiscal integration is workable after all and he offers, as an example, Latvia:
Latvia which has a currency pegged to the euro, testifies to the success of this policy. Contrary to commentators who predicted disaster for Latvia early last year unless it gave up its hard peg - in line with advice from the commission - it did not devalue its exchange rate. A real effective devaluation was achieved through severe cuts in nominal income. Today its economy is growing again. Those outside "experts", who always seem to know what is good for Europe, should take note.
So to be clear about this, the Latvian economy suffered a 4.2 percent contraction in 2008. By way of comparison, in the horrible year of 2009 the US economy contracted 2.44 percent. So that was a very bad recession, much worse than the American recession. At this point, so called "outside `experts'" predicted disaster for Latvia in early 2009 unless it devalued its exchange rate. Latvia declined to devalue and its GDP shrunk 18 percent! That's the disaster right there. Overall GDP growth for 2010 is forecast to be slightly negative again. So, yes, Latvia has returned the growth. But the toll was terrifyingly high.
I despair, I truly do.

Of all the ways of organizing banking, the worst is the one we have today — Mervyn King, 25 October 2010
by Migeru (migeru at eurotrib dot com) on Fri Dec 17th, 2010 at 02:42:35 PM EST
[ Parent ]
Migeru:
A real effective devaluation was achieved through severe cuts in nominal income.

Oh, here's a German admitting that what Germany did and continues to do is called "real effective devaluation"?

Germany has been cheating on us all along?

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Dec 17th, 2010 at 02:54:57 PM EST
[ Parent ]

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