Greece Showed What Happens When You Cannot Print Your Own Currency
The eurozone debt crisis was not simply about excessive borrowing. It was about borrowing in a currency the borrower did not control, which converts a fiscal problem into a solvency one.
The Distinction That Matters
A government borrowing in its own currency can always meet nominal obligations, because it controls the issuer of that currency. The consequences of doing so may be severe, including inflation and currency depreciation, but technical default is a choice rather than a necessity.
A government borrowing in a currency it does not control is in a fundamentally different position. It is closer to a company or a household. If revenues fall short and lenders refuse to roll the debt, it defaults.
Eurozone members borrow in euros, which the European Central Bank controls. That is the structural fact underneath the entire crisis.
What Went Wrong
After joining the euro, Greece borrowed at interest rates close to Germany's. Markets had effectively priced the debt as though a euro obligation carried similar risk regardless of issuer, which turned out to be a mispricing of the credit rather than a genuine convergence in fundamentals.
Cheap borrowing funded deficits. Revised deficit figures revealed a much larger fiscal gap than reported. Yields rose sharply, and rising yields raised debt service costs, which widened the deficit further.
A country with its own currency facing this would devalue and inflate. Greece could do neither, so the entire adjustment had to come out of wages, employment, and output.
Internal Devaluation
The standard adjustment for an uncompetitive economy is currency depreciation. Exports become cheaper abroad, imports more expensive, and the trade balance improves without anyone negotiating a pay cut.
Inside a currency union that option does not exist. The alternative, described as internal devaluation, means lowering costs directly through falling wages and prices.
This works in theory and is brutal in practice. Wages are sticky downward, so the adjustment happens substantially through unemployment rather than through lower pay. Falling prices also raise the real value of existing debt, which worsens the burden the adjustment was meant to relieve.
The Restructuring
The eventual private sector restructuring imposed very large losses on bondholders and ranks among the largest sovereign debt restructurings ever conducted.
An important detail is who held the debt. Greek banks held substantial quantities of Greek government bonds, so writing down the sovereign debt damaged the domestic banking system directly, which then required its own recapitalization. This link between a government and its banks, each weakening the other, is called the sovereign bank loop and it was one of the crisis's most important lessons.
What Changed
The turning point in market terms was the European Central Bank's commitment to do whatever was necessary to preserve the euro, and the announcement of a programme to purchase sovereign bonds under conditions.
Notably, that programme was never actually used. The credible commitment to act was sufficient to compress yields, which is the same announcement effect seen in other central bank interventions. The willingness to buy removed the scenario investors feared, so the buying was not required.
The Bottom Line
Greece could not devalue, print, or inflate, so adjustment came through unemployment instead. Borrowing in a currency you do not issue changes the nature of the obligation, and that distinction is the whole crisis in one sentence.