1

A Loan and a Prayer

NEW YORK – The countries known collectively as the PIIGS – Portugal, Ireland, Italy, Greece, and Spain – are burdened with increasingly unsustainable levels of public and private debt.   Several of the worst-hit – Portugal, Ireland, and Greece – have seen their borrowing costs soar to record highs in recent weeks, even after their loss of market access led to bailouts financed by the European Union and the International Monetary Fund. Spanish borrowing costs are also rising.

Greece is clearly insolvent. Even with a draconian austerity package, totaling 10% of GDP, its public debt would rise to 160% of GDP. Portugal – where growth has been stagnant for a decade – is experiencing a slow-motion fiscal train wreck that will lead to public-sector insolvency. In Ireland and Spain, transferring the banking system’s huge losses to the government’s balance sheet – on top of already-escalating public debt – will eventually lead to sovereign insolvency.

The official approach, Plan A, has been to pretend that these economies suffer a liquidity crunch, not a solvency problem, and that the provision of bailout loans – together with fiscal austerity and structural reforms – can restore debt sustainability and market access. This “extend and pretend” or “lend and pray” approach is bound to fail, because, unfortunately, most of the options that indebted countries have used in the past to extricate themselves from excessive debt are not feasible.

For example, the time-honored solution of printing money and escaping debt via inflation is unavailable to the PIIGS, because they are trapped in the eurozone straitjacket. The only institution that can crank up the printing press – the European Central Bank – will never resort to monetization of fiscal deficits.