Time for Cryptonomicon
In the end, Greece, the eurozone’s other members, and Greece’s creditors will have to accept that the country is insolvent and cannot service its existing debt. At that point, Greece will default.
Feldstein points out that there are a number of ways in which Greece can repay its current bondholders less than what they are owed. Bear in mind that Feldstein is a long-term skeptic of the euro. Other economists used to be less skeptical, but we are not hearing much from them these days.
Paul Krugman makes Feldstein sound like a euro-bull. Krugman writes,
the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling.
Nick Rowe thinks that the European Central Bank will be constrained by its internal procedures to permit a contraction of the money supply.
If the ECB won’t create enough money, some Eurozone governments will eventually start creating their own.
Feldstein, Krugman, and Rowe are focused on the problems with the euro as a common monetary unit. But how does the monetary problem relate to the fiscal crises? Peter Boone and Simon Johnson explain,
The underlying problem is the rule for printing money: in the eurozone, any government can finance itself by issuing bonds directly (or indirectly) to commercial banks, and then having those banks “repo” them (i.e., borrow using these bonds as collateral) at the ECB in return for fresh euros. The commercial banks make a profit because the ECB charges them very little for those loans, while the governments get the money – and can thus finance larger budget deficits. The problem is that eventually that government has to pay back its debt or, more modestly, at least stabilize its public debt levels.
This same structure directly distorts the incentives of commercial banks: they have a backstop at the ECB, which is the “lender of last resort”; and the ECB and European Union (EU) put a great deal of pressure on each nation to bail out commercial banks in trouble. When a country joins the eurozone, its banks win access to a large amount of cheap financing, along with the expectation they will be bailed out when they make mistakes. This, in turn, enables the banks to greatly expand their balance sheets, ploughing into domestic real estate, overseas expansion, or crazy junk products issued by Goldman Sachs. Just think of Ireland and Spain, where the banks took on massive loans that are now sinking the country.
Given the eurozone provides easy access to cheap money, it is no wonder that many more nations want to join. No wonder also that it blew up. Nations with profligate governments or weak financial systems had a bonanza. They essentially borrowed funds from the less profligate elsewhere in the eurozone, backed by the ECB.
Neal Stephenson’s Cryptonomicon has a plot that revolves around an attempt to create a private money backed by gold, not by governments. I would say that if an entrepreneur could create a credible private money, now would be a really opportune time to bring it to market.