Spreading Haircuts in the EU?

by Dirk Ehnts

If and when Greece gets a hair cut of 20% (50%?), all other countries will ask for the same.  A Latvian newspaper reports (via Google Translate):

If indeed Greece, for obedience to write off 50% debt, the Latvian will certainly be asked about Prime Minister Valdis Dombrovskis responsibility for his assessment of the performance.

Latvia during the crisis period showed an absolute obedience. Latvia took the credit, as ordered, and refused to give up the next portion (Hungary refused), the Latvian did not exercise its sovereign right to devalue the national currency and quickly overcome the crisis. A few months instead of the internal devaluation lasted two years. The Latvian government obediently allowed their citizens to use the experimental rabbits for a new industry – an experimental economy, the small area level on line are tested in crisis-solving scenarios before implementing them in a much larger scale in the EU or the U.S.

So, Latvians complain that they were used as “experimental rabbits”. There was no devaluation, no hair-cut on the debt, and now they feel cheated and complain that should have played hard against the IMF. As a country that regained its independence only quite recently, maybe there was a lesson to learn for Latvia. If there is something you don’t like, speak out, use your rights (freedom of speech, demonstrations, etc.) to voice your concerns.

For Europe as a whole, the Greek case will set a precedent. Other countries will follow suit and argue that if Greece gets a 50% off, they should get one as well. The European Financial Stability Facility (EFSF) is €440 billion. Here are the losses from a 50% haircut on some euro zone members’ sovereign debt:

• Ireland: €115,000,000,000
• Greece: €532,900,000,000
• Portugal: €497,800,000,000
• Spain: €2,166,000,000,000
• Italy: €2,223,000,000,000

Under this scenario, Spain and Italy would not be bailed out under the EFSF.  Some combinations of Ireland, Greece and Portugal could be bailed out, but not all three.

There are two ways out of this, promising to bail out all countries without any limits (“more Europe: euro bonds + X”), or, letting them fail (“less Europe: post-euro is pre-euro”).  A middle way will not lead to a solution and will institutionalize financial market instability.  It seems that this is what Europe’s politicians want right now – while inquiring on how to leverage the EFSF, just in case – and reminds me of an old quote from Otto von Bismarck (Minister President of Prussia from 1862–1890):

Politics is the art of the possible.

However, one wonders who determines what is possible and what is not. Hopefully, the ideas of economists play a role in this, and people – including policy makers – will come to their own conclusion about what works and what doesn’t.  As long as what is possible is determined by the opinions of networks of people who gather around some ideology or the other, the outlook on the policy front will continue to look bleak.  Or, put differently (by John Steinbeck):

The ability to think differently today from yesterday distinguishes the wise man from the stubborn.

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Analysis and Opinion articles by Dirk Ehnts

About the Author

Dr. Dirk Ehnts is a research assistant at the Carl-von-Ossietzky University of Oldenburg (Germany). His focus is on economic integration and economic geography, covering trade, macro and development. He is working at the chair for international economics since 2006 and has recently co-authored a book on Innovation and International Economic Relations (in German). Ehnts has written at his own blog since 2007: Econblog 101. Curriculum Vitae.