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April 16, 2009

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"Finally, nobody stood ready to bail out Argentina if it defaulted; the E.U. would almost certainly bail out Greece."

How does that square with the (public) German reluctance to bail out the Eastern Europeans? Is Greece getting a bye because it's Old EU?

(BTW, the error appears to be confined to my work machine, but only to your site. Quite odd. I'll get you the precise message on Monday.)

There are a few issues here. First is, there's a difference between a eurozone defaulter and a non-eurozone defaulter, although both types are likely to get an E.U. bailout.

Second thing, of course, is that the Eastern Europeans haven't defaulted. We don't know what Brussels (with, obviously, a de facto German veto) would do if that looked likely.

Third thing is that the Germans have, as you say, raised the possibility of bailing out eurozone members should they default.

There are three likely reasons for that. (1) A eurozone-member default is more likely to do bad things to eurozone capital markets and economies than a default outside the eurozone; (2) eurozone governments in Ireland and Greece (and to a lesser extent Spain) are closer to default (AFAIK --- Hugh?); and (3) Germany believes that the E.U. can make eurozone members suffer enough for defaulting (or directly control what they subsequently do) that moral hazard won't be an issue.

How they actually structure any bailout, should it be necessary, is a whole 'nother kettle of fish. My money is that the European Investment Bank would be turned into a de facto bond-issuing agency for the entire E.U. But mileage varies.

Hopefully it won't come to that. But my current opinion is that the eurozone would be behooved to admit more strongly that they're going to bail out euro-using countries that get into debt spirals because of the current crisis, rather than run the risk of seeing a country slide into an Argentine-style debt spiral.

I see you've got blue jeans on in on picture. George Will does not approve

"the eurozone would be behooved to admit more strongly that they're going to bail out euro-using countries that get into debt spirals because of the current crisis"

That's been my take. It seems to me like they run a serious risk of contagion otherwise, and the entire "European Project" has been under enough political strain as it is.

As an aside, I recall running into a website taking non-monetary bets on the possible demise of the Euro when I was doing a project on OCAs at NYU. I believe I took a mid-'07 box under the assumption that the business cycle should have turned by that point, and there was no way the Germans were going to pony up for more transfers or that the Italians were going to make it without a devaluation. I think I called the cycle close, but possibly I underestimated the Germans (though perhaps not their rhetoric.)

"Germany believes that the E.U. can make eurozone members suffer enough for defaulting (or directly control what they subsequently do) that moral hazard won't be an issue."

Heck of a lot of fiscal pain for non-defaulters, though. My read would have been that geographic transfers in the US make some level of local austerity acceptable. California can cut because the Feds are always there as a backstop. If, say, the Italians need to do the same, though, both the transfer system and the political ties are weaker.

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