The Eurozone Debt Crisis—The Options Now (Digest Summary)

The authors consider the prospect of the eurozone debt crisis spreading across peripheral Europe and into such large countries as Italy and Spain. They also discuss the potential options available to deal with the situation. Unfortunately, there seem to be no painless or riskless options.

The authors summarize the eurozone’s journey from the start of the crisis in Greece in early 2010 to today. They argue that fears of contagion, concerns about balance sheet damage to the main lenders (i.e., French and German banks), and desires to maintain the reputation of the euro were the key motivating factors behind the €110 billion Greek bailout and subsequent actions. Unfortunately, it is quite evident that attempts to contain the crisis have fallen drastically short.

According to the authors, the European Central Bank and other official sector lenders consider the debt crisis to be a temporal issue and are treating it as a short- to medium-term anomaly. With this in mind, and drawing on experiences from the Latin American debt crisis, the authors identify five potential options for coping with the current crisis. Most of the options are focused on various ways to convince lenders to offer lower-yielding debt to the peripheral countries, but the authors believe there is ultimately only one viable option: debt reprofiling. They highlight the success of Uruguay in using this method to restructure its debt in 2003. This approach would mean extending all maturities for sovereign debt instruments and giving borrowers more time to ride out these temporal problems before having to pay back principal. Investors would be affected by reduced net present values, but this result should be far more palatable than major principal or interest repayment reductions.

The discussion prompts me to consider the likelihood of contagion across the core European countries. After all, one could argue that Italy and Spain are not entirely peripheral in the context of Europe. The authors highlight the artificial dichotomy that the eurozone has created with one currency but different levels of sovereign risk across Europe. For continued success, a common monetary policy is needed, but the varied political and cultural spectrum across the region will make it difficult to achieve, let alone sustain.