Wednesday, April 28, 2010

How Do You Say "Riesgo Pais" in Greek?

My international economics students have been reading And The Money Kept Rolling In (And Out), Paul Blustein's excellent chronicle of Argentina's 2001 financial crisis. Blustein tracks the "riesgo pais" (literally, country risk), the yield gap between Argentina's dollar-denominated debt and US Treasuries, which rises inexorably as confidence in Argentina's ability to maintain its Dollar peg and fully repay its debts ebbs.

This Times story on the Greek crisis included a graph of the extra yield on Greek relative to German government debt:Yikes!

Paul Krugman suggests that a Greek exit from the euro would be similar the end of Argentina's "convertibility" system. He writes:
[T]he Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling.

And if Greece is in effect forced out of the euro, what happens to other shaky members?

I think I’ll go hide under the table now.

But R.A. of Free Exchange believes there is good reason to think the crisis will be defused:

The situation is troubling, but I think it's worth taking a step back and a deep breath. It is fairly easy to sketch out the ways in which the current crisis could develop into a real economic catastrophe. Sovereign debt and bank concerns in Greece and Portgual could generate pressure on borrowing costs for Italy and Spain and trouble for Italian and Spanish banks. Italy and Spain are big economies, however, and so the sums involved are quite large (in terms of potential bail-out sizes and debt exposure). Real trouble in Italy and Spain would place significant pressure on northern European political systems and economies, and on the euro zone. Depending on how the chips fall, Europe could face capital flight and a new wave of real economic pain. Given the size of the European economy, that would mean trouble for the global financial system and unpleasant headwinds for the global economy.

But things needn't turn out like that. Germany has behaved wildly irresponsibly over the course of this crisis, but its leaders may yet come to their senses (certainly IMF leaders are spinning doomsday scenarios for them, much as American officials laid out the apocalyptic potential of a defeat of the TARP legislation). A Greece restructuring is all but inevitable, but the cost associated with making Greek creditors whole is very small relative to the potential losses associated with continued chaos. While Greece is beyond the brink, other countries have room to rein in their deficits if given time; all that's needed is an effort to avert a liquidity crisis.

The risk is real, but the potential consequences are clear, and it is within the ability of the IMF and European finance ministers to avoid a disaster.
Furthermore, as noted by Matthew Yglesias, a "bailout" of Greece is really a bailout of Greece's creditors. As a side effect of its current account surpluses, many of those creditors are in Germany, so even though its tough politics, Chancellor Merkel now seems to recognize she has strong incentives to do something. See also Felix Salmon, who is not optimistic.

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