As the eurozone’s weakest members crawl out of their longest recession in modern history, their prospects of recovery are weighed down by a crushing mountain of debt far heavier than before four years of financial crisis.
Italy, Greece, Ireland and Portugal all have public debt well in excess of annual economic output and risk a Japanese-style «lost decade» of grindingly low growth and high unemployment as they slowly repay their way out of trouble.
The average ratio of debt to gross domestic product in the 17-nation single currency area stands at 95 percent – lower than in the United States and far less than Japan but dangerously high for ageing societies that cannot individually print money or devalue.
The official European Union line is that each bailed-out country must clean up its own mess and grow its way back to health without debt relief or mutualization, except perhaps for Greece, which has long been declared a special case.
“As Margaret Thatcher used to say: TINA – There Is No Alternative,» said Graham Bishop, an economic consultant. Fiscal discipline and pro-market reforms to liberalize labor contracts, break trade union wage bargaining power and curb welfare and pensions are the only road to salvation, he argued.
Yet other economists – and a closet minority of EU officials unwilling to break ranks publicly with the orthodox line – say that policy prescription is politically and socially untenable and Europe will have to consider some form of broader debt relief, perhaps via the European Central Bank.
“Ideally the eurozone would combine a symmetrical budget policy with debt monetization by the ECB,» Belgian economist Paul De Grauwe at the London School of Economics wrote in an essay for the Centre for European Reform.
Under such a policy, low-deficit countries like Germany with room for maneuver would run a more expansionary budget to balance out spending curbs in peripheral states, while the central bank would buy up and retire weaker states’ bonds.
Neither option is likely, given Germany’s fear of inflation and the vehement resistance across northern Europe to any perceived sharing of the burden of other euro countries’ debts.
De Grauwe said the alternative was that countries like Greece and Portugal would default sooner or later, since politicians in those countries would not accept being forced to transfer resources for years to rich northern creditors.
Yet default remains taboo in the euro area even after Greece’s imposition of losses on private bondholders in 2012.
Two other economists who analyzed the options in a paper on the economic website VoxEU in August concluded that the only realistic and effective option would be for such countries to default by selling monetized debt to the ECB.
Arguing that Europe’s debt crisis was still getting worse despite appearances to the contrary, Charles Wyplosz, professor of international economics at the Graduate Institute in Geneva, and Pierre Paris, CEO of Banque Paris Bertrand Sturdza, said this would amount to «burying the debt forever».
Under their scheme, the ECB would buy up 1.2 trillion euros in bonds of the most indebted countries and exchange them for a perpetual interest-free loan that would never be repaid unless the bank was liquidated, effectively eliminating the debt.
Such moves have sometimes caused runaway inflation in the past, but the authors argue it would be unlikely to do so now because credit markets are so weak that increases in the monetary base do not actually expand money in circulation.
Their plan would go far beyond the ECB’s current policy of offering to buy up short maturity bonds of states that apply for a precautionary loan from the euro zone’s rescue fund and accept heavily monitored EU/International Monetary Fund austerity.
The authors examine other avenues for debt reduction such as running big budget surpluses, selling off public assets, making creditors take losses on bond holdings, or debt forgiveness by creditor governments.
Even taken together, those options would be insufficient, politically unacceptable or merely shift the burden to weak banks and «forgiving nations» such as Germany, which would see its debt ratio soar to perhaps 110 percent, they say.
Historians who have studied past episodes of very high debt in the last three centuries say inflation, devaluation, roaring economic growth or selective default have often reduced the burden without massive pain.
Nicholas Crafts, professor of economic history at Warwick University, said the orthodox fiscal approach of running a big budget surplus had enabled Britain to reduce its debt over the century after the Napoleonic wars from 200 percent of GDP to 25 percent in 1913 in the eve of World War One.
Another tactic, used successfully by the United States and Britain after World War Two was «financial repression», forcing real interest rates down to very low levels through the capture of holders of government debt.
Banks and investors were constrained by capital controls and reserve requirements, paying an effective «inflation tax» that helped reduce the public debt ratio.
Roaring economic growth fuelled by productivity gains and a baby boom helped ease the burden in the 1950s and 1960s. Yet neither looks likely in the near future given ageing societies, chronic unemployment, depressed demand and high savings.
Crafts said 20th century defaults had ranged from the Bolsheviks’ total repudiation of Russia’s debts after the Soviet revolution to partial or long payment deferments and debt moratoriums in Latin America in the 1930s.
More recently, Western powers had tried to postpone or prevent defaults in Latin America in the 1980s due to the exposure of their own banks – as is the case in the euro zone – leading to prolonged phases of «muddling through».
“In the 1930s, devaluation and default would undoubtedly have been the choice in response to the eurozone’s current problems, because countries still had their own currencies,» Crafts said. «But for the eurozone, what seems more likely is 1980s-style muddling through.”
Eurozone policymakers say «financial repression» is the least politically difficult option to ease debt while trying to spur growth and productivity through economic reforms.
“I’d personally be in favor of financial repression, but there are spoken and unspoken ways of dealing with it. The ECB will play a key role,» said a senior eurozone policymaker, who declined to be identified because of the market sensitivity of such issues.
Economist Bishop said the impact would effectively to be to make savers and retirees pay over time for debt reduction by denying them any real return on government bonds held by their pension funds and savings instruments.
“Since bondholders have historically got a 2 percent real return on government bonds and are getting virtually none now, that’s equivalent to giving them a 2 percent haircut a year, and it will go on for a long time,» he said. «Over a decade, that amounts to a 20 percent cut in the debt.”
But the windfall is unevenly shared. Safe haven countries such as Germany and France will reap more benefit than states whose debt is perceived as riskier, such as Portugal or Italy.