New Internationalist

The Euro debt crisis: bailout or default?

December 2011

Turmoil in the Eurozone keeps throwing up a fundamental question. Which is the best strategy in such cases: default or bailout? Stergios Skaperdas and David Olive argue the example of Greece.

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At the beginning of 2010 it became clear that Greek public debt was becoming unsustainable. Greece could no longer borrow from the international bond markets.

If, at the time, Greece had defaulted with a 30 per cent or greater ‘haircut’ (loss) imposed on bondholders, Greek debt would have become sustainable in the long run. The country would have had to borrow internally, perhaps issue IOUs (as it has done already) and impose a few modest cuts. The effect of such a policy would have been mildly recessionary.

What was done instead by the EU/IMF/ECB ‘troika’ was to provide Greece with loans so as to cover its budget deficit without default, in exchange for increasingly draconian budget cuts, tax increases and institutional changes of dubious value. Existing bondholders continued to have their interest and maturing principal fully paid.

The effect of this policy has been a fast downward spiral of the economy. Since debt keeps increasing and the country keeps getting poorer fast, debt is becoming ever less sustainable. The debt-to-GDP ratio went from 115 to 160 per cent in less than two years.

Even the German Chancellor recognized that this charade cannot continue.


Greece cannot be allowed to default. There is no such thing as an ‘orderly’ Greek default, as some have called for. All the banks would collapse, an incredible hardship on everyday Greeks, whose current social upheaval would intensify. Future Greek debt would find no buyers globally except at usurious rates. Effectively, Greece would no longer be able to borrow the funds that sustain anything remotely like its people’s current way of life.

Arguably worse, leading banks elsewhere, notably in Germany, London and New York, would suffer huge losses on their holdings of sovereign euro debt that would destabilize state finances for governments across the continent and in Britain obliged to bail out these ‘systemically critical’ lenders.

The German Chancellor isn’t exaggerating about the ‘Lehman effect’ of a Greek default, a reference to the global financial meltdown following the September 2008 collapse of New York investment bank Lehman Brothers Holdings Inc. To invoke a hoary Cold War term, there is a domino effect to consider here: if the eurozone allows one country to default, what confidence can global bond buyers have in the debt of other troubled euro-economies?

The argument that last year’s first effort at a Greek bailout was bungled is valid. So was the Irish bailout. In each case, the bailout loans bore unmanageably high interest rates; and Greece was implored to engage in harsh austerity at impractical speed. But then, euro leaders repeatedly accused of sloth in responding to the crisis have been dealing with an unprecedented event. The eurozone is just a dozen years old, and its architects made no plans for coping with defaults they did not anticipate.

Thus the rescue has been a work in progress. The larger European Union’s survival without a eurozone is doubtful. The biggest losers in that event would be the major economies, whose robust trade with their neighbours has seen Europe eclipse the US in economic size. Not coincidentally, the EU’s tenure has marked the longest period of uninterrupted peace in European history. There is too much at stake to allow any eurozone member nation to default.


Yiorgos Karahalis / Reuters
Anti-austerity rally in Athens’ Syntagma Square. Yiorgos Karahalis / Reuters

If default of a small country in the eurozone, amounting to 2.7 per cent of its GDP, threatens to blow up the world’s financial system along with the eurozone, then there is something seriously wrong with both the financial system and the eurozone

I recognize that the blow-up scenario is serious. In that case, if trillions of losses can be expected, giving 180 billion euros in grants to Greece to pay off half of its debt would solve the problem. This will not be done, not because it can’t be done but because, even if Greece did not exist, there would be Portugal, Ireland, Spain, Italy and other countries that pose the same threat, with only a time difference.

The problem is dual: the financial system was not fixed after 2008 and the eurozone has no hope of functioning without political unification. Thus an orderly break-up of the eurozone and fixing the financial system should be urgent tasks now.

We cannot continue having the bankers threaten to blow up the world unless everybody does what the bankers demand.


Kai Pfaffenbach / Reuters
Protesters set up camp outside the European Central Bank in Frankfurt to show their anger at bankers and politicians. Kai Pfaffenbach / Reuters

How could default by a small country bring Europe to its knees, and how could the ‘Balkan powder-keg’ explode with the loss of an unprecedented eight million lives in the First World War? Big problems start small. It’s the history of our species.

Yes, the global financial system remains in disrepair after its faultlines were so dramatically revealed in 2008-09. And the eurozone needs greater political and fiscal unity. Indeed, the latter is a centrepiece of the latest ‘comprehensive strategy’ for eurozone reinvention.

But first things first. As a practical matter, Germany still relies on its eurozone peers for 40 per cent of its export revenues. Confidence, that precious commodity, must be restored among global investors – individual, corporate and institutional. The place to start is Greece, ground zero of the panic. But Europeans from Sheffield to Poland’s eastern frontier must be relieved of the uncertainty of a wider economic implosion for want of the liquidity injection required now to ensure the functioning of all sovereigns.


Some big problems may start small but small problems rarely lead to big ones. When they do, they are often just a symptom, not a cause. From Greece to Ireland, from the Bank of America to French banks or to some obscure special investment vehicle in the Caymans, there are problems everywhere. They are all symptoms of a sick financial system and a problematic eurozone.

Even if Greece were to disappear tomorrow, the world’s confidence is unlikely to recover as long as the two big problems are left festering. I have yet to see a realistic proposal for Greece that does not involve some form of default. The 26 October agreement included a 50 per cent haircut to bondholders – an example of ‘orderly’ default.

If not an orderly default then a disorderly one becomes highly likely. Only an outright grant to Greece could prevent the need for a default but I don’t see how it could occur.

All parties would better prepare for a default then. Unforeseen events will take place but it will also likely force longer-term solutions for finance and the eurozone.


If sovereign bondholders aren’t a tad sanguine about taking a sizeable ‘haircut’ in a renegotiation of Greek debt, they should be. Indeed, investors are getting a hard lesson on the new euro-economics, in which for political reasons they will have to share in the sacrifice required to keep the eurozone fiscally whole. That the lesson has been absorbed is clear from the sudden (relatively speaking) ill repute of Italian and Spanish debt, and the shocking run on French obligations. This is not a Greek crisis, but a systemic one. And indeed, the opportunity cannot be missed to use the upheaval as a catalyst for sweeping fiscal reforms across the eurozone. Those will be made more palatable by an Italian taking charge of an ECB widely regarded as the former German central bank with a new name.

Stergios Skaperdas is Professor of Economics at the University of California, Irvine. Born in Greece, Skaperdas has worked with the Center for the Study of Democracy and is a Research Fellow of the Center for the Study of Civil Wars at the Peace Research Institute in Oslo, Norway.

David Olive is the Business and Current Affairs Columnist for the Toronto Star and the author most recently of An American Story: The Speeches of Barack Obama: A Primer (2008).

Front cover of New Internationalist magazine, issue 448 This feature was published in the December 2011 issue of New Internationalist. To read more, buy this issue or subscribe.

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  1. #1 Robin Tudge 16 Nov 11

    Give it up, let the Greeks have the Drachma back. If they hadn't given it up in the first place, the current debt crisis would have panned the Drachma, then Europe's tourists would have flooded in as Greece is suddenly dirt cheap, like neighbours coming round with stuff after a housefire, and the situation would have righted itself. Instead, Europe's taxpayers get to see their holiday money chucked into the furnace of bailouts, as the Franco-German Eurocrats seek to save their gargantuan folly by battling the markets, as Greece, Italy and possibly Spain fall from the table and take the tablecloth and everything on it with them, while neither the Italian nor Greek people get any say as their elected leaders buy the farm.
    The euro doesn't work, the Brussels project is dying, and the markets are making their usual capricious killing by way of murdering democracy. Still, tens of millions face worsening poverty.
    Better, the northern Mediterranean needs a Latin Spring, like the Arab Spring across the sea, before they're dragged into the gutter and told to shuttup in the process.
    Really, with that as the reality, what is there to lose?

  2. #2 Apropos 01 Dec 11

    Forget the bailout. Let's focus all our efforts on a democratic socialist alternative to capitalism. Anything else is pussyfooting around with a bankcrupt system that has clearly had its day. There needs to be a fundamental change in the way we live. We need to replace free market madness, with its built-in greed and selfishness, with a system of sharing and co-operation. To quote the late, lamented Bill Shankly: 'The socialism I believe in is not really politics. It is a way of living. It is humanity. I believe the only way to live and to be truly successful is by collective effort, with everyone working for each other, everyone helping each other, and everyone having a share of the rewards at the end of the day.'

  3. #3 ec 02 Dec 11

    My economics doesn't go far beyond 101, but I'm startled that bailout and default are being presented as the only two options. Greece is maybe a special case, but don't most other countries have other options, however hard they may be? They can't all default on or get bailed out by each other!

  4. #4 bob 08 Dec 11

    Bailing out one eurozone country after another will simply create a two-tier Europe with the big boys (or girls) such as Sarkozy and Merkel ‘generously’ helping out their neighbours (while still moaning endlessly about it) in order to re-assert their supremacy and call in favours later. It bodes disaster. It’s a sham of democracy and a sham of equality.

  5. #5 abasletat 08 Dec 11

    It seems like there are some pretty striking similarities to Argentina a few years back. They defaulted and the sky didn't fall in. I guess the Greeks should strongly consider doing the same. That way they may be able to preserve some notion of social welfare and workers rights in what will otherwise end up as being a bosses state.

  6. #6 Brad 08 Dec 11

    While I don't normally approve of going bankrupt so as not to pay creditors (fully) in the case of Greece and others in a similar position I say bring it on - otherwise we are just perpetuating the problem in which big banks always win.

    If this starts a domino effect and there is global financial meltdown, so be it. It's what the rotten system deserves, and though times would be hard it would give a chance to rebuild a more equitable system. And if it doesn't then Greeks would at least be more in control of their own destiny.

    So, default, what is there to lose.

  7. #7 Lucy Brel 08 Dec 11

    Stergios is right. 'We cannot continue having the bankers threaten to blow up the world unless everybody does what the bankers demand.'
    But what I'd like to know is, why isn't Goldman Sachs in the dock? It was this 'investment' bank that helped the former Conservative government of Greece cook the books to hide the full extent of the national debt. Surely Goldman Sachs is an accesory to the crime of fraud on a massive scale? But no, the bank earned 300 million dollars from selling Greece the means to cheat and has gone on to make more milions out of the crisis. How about a fine, at least? A firm that pays its CEO nine million dollars a year can surely afford to pay some of the toxic consequences of its dodgy practices.

  8. #8 Tom Ash 12 Dec 11

    Neither bailout nor default are attractive options. Bailouts are never popular; it's entirely predictable that German voters aren't happy about bailing out Greece, even if they're shooting themselves in the foot. Meanwhile, historical examples of defaults aren't pretty at all; people's savings get wiped out, and defaulting countries are suddenly starved of credit and so forced to balance their budgets, with much pain resulting.

    But, all that said, either option has to be better than doing nothing, or taking the half-measures that Germany's been willing to allow so far.

  9. #9 BrianG 05 Jan 12

    The big corporations, banks, and stock markets go through their periodic crisis and small businesses,professionals and employees get blamed for being too greedy. Then the national governments are expected to bailout the big monopolies and banks to 'save the economy'. Nice trick, as long as you have the right idle rich and lawyers elected to government.

  10. #10 Jack Rainbow 21 Sep 12

    Is it true that Mario Draghi, now head of the ECB, formerly deputy Chief of Goldman Sachs Europe,helped to cook the books so Greece could make its debt appear below 3 percent of GDP and thus join the Eurozone?

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This article was originally published in issue 448

New Internationalist Magazine issue 448
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