Bad Romance

by David O. Beim

Foreign Policy
October 19, 2011

Greece should never have been a member of the eurozone -- and at this point the best way to save both of them from economic catastrophe is to end the relationship.

The economic medicine being applied in Europe is not working. In fact, the patient is getting worse: Greece's economy is collapsing and its debt is rising exponentially, prompting harsher austerity proposals and increasingly violent protests, such as the one on Oct. 19 in front of Athens's parliament. The doctors have responded by prescribing ever-larger doses of the same: ever-larger funds to lend Greece ever-larger amounts and force ever-larger austerity measures upon the country -- a course that can only lead to an ever-larger failure.

And yet the underlying problem is both familiar and resolvable: several governments in Europe have borrowed more than they can possibly repay. Such over-borrowing by governments is not unusual. It has happened repeatedly over the years and has one effective solution: the debt needs to be reduced. This is hardly impossible -- Mexico, Brazil, and seven other Latin American governments did it two decades ago following the prolonged debt crisis of the 1980s, reducing their respective debts by 50 to 70 percent by issuing tradable dollar-denominated "Brady bonds" in exchange for their outstanding debt. Banks took large losses, long foreseen by the markets, and proceeded to rebuild their capital. Prosperity was quickly restored to the over-indebted countries.

Tragically, the eurozone leadership has for three years refused even to consider this most obvious of solutions. Instead, the leadership has been determined to raise ever-larger "bailout" funds to lend ever more to the stressed governments. These new European Financial Stability Facility (EFSF) loans do forestall default in the short term, but they add to the debt total of Greece and other stressed countries and so make the long-term problem far worse. If a borrower has too much debt, one does not help him out by lending more -- that only digs him in further. This is not a "bailout" at all. The defaults, when they come, will only be larger. The markets clearly see this: Sovereign bond rates and credit-default swap spreads, which are closely related to the probability of default, keep climbing ever higher.

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