Germany and other AAA rated eurozone members could have bailed out Greece for as little as €200bn if they had acted quicker and ignored "moral hazard" principles, says Francis Scotland, director Global Macro Research at Brandywine, a subsidiary of Legg Mason.
We doubt that a rolling series of sovereign debt defaults is at hand. There are plenty of countries that have high debt and need to redress their fiscal imbalances to put them on a sustainable footing. But the pre-conditions for a global sovereign debt contagion are not evident. The world’s most important central banks are pursuing aggressive monetary expansion and the world economy is advancing in most places.
Most of the OECD is in a debt trap and any country in this situation will ultimately hit a wall of unsustainability if its interest bill rise too high relative to domestic savings and/or is unduly reliant on foreign capital to fund growth. In the current environment, skittish investors are even less willing to wait for the whites of the eyes of insolvency before bailing. For countries with no independent monetary policy the endpoint is insolvency and default. For countries with independent monetary policy the end point is often default and a currency devaluation.
Currently, the only two countries facing immediate insolvency are Greece and Portugal. The market has been preparing for a Greece credit event for a long while. In our view Portugal is also a high probability candidate for a debt “restructuring.”
Elsewhere in Europe, such as in Italy and Spain, our view is that sovereign stress reflects a collapse of confidence in Europe’s policy process and institutions. Whether this was a calculated gamble to force a fiscal union or sheer policy incompetence is a debate for financial historians. In the end, the ECB has resorted to full-scale quantitative easing which is a crucial and necessary remedial step. Assuming that these measures and others likely to follow are able to prevent a more dramatic credit contraction, Europe should be able to stumble along buying time for Italy and Spain. At a minimum, the changed stance of the ECB kicks the can a long way down the road. The best case outcome is a multi-year period of low rates and fiscal rehabilitation.