Utopia, you are standing in it!

The Greeks initially did a fine job in squeezing huge subsidies and debt write-offs! The Irish played by the rules, guaranteeing bank bond holders to which they had no obligation, but got screwed.

Through history, sovereign defaults come in clusters. Is Greece the start of one? on.wsj.com/1V3XkxR via @WSJ http://t.co/Oy9aMPoHrt—
Greg Ip (@greg_ip) July 15, 2015

Arellano, Conesa, and Kehoe explain in Chronic Sovereign Debt Crises in the Eurozone, 2010–2012 that the post-GFC recession in many Eurozone countries created an incentive to gamble for redemption.

This gamble for redemption is betting that the post-2008 recession will soon end.

• If Greece sold more bonds to smooth government spending in the interim, and if the Greek and EU economies recover, the stronger revenue growth will pay off the enlarged Greek government debt.
• Under some circumstances, this policy is the best that a government can do for its country, but it carries a risk!
• If the recession goes on for too long (and it did in southern Eurozone), a government will either have to stop increasing its debt or default on its bonds.

The global bond markets will anticipate this prospect of default as a country’s government debt accumulates and will seek higher and higher interest for new bonds, and importantly, to roll over existing Greek Government bonds.

EU policies that result in higher interest rates on government bonds and high costs of default provide incentives for a national government to reduce its debts and avoid sovereign default.

The paradox of how the euro itself fueled the imbalances behind the Greek crisis, by @greg_ip on.wsj.com/1LotakJ http://t.co/ZgA6vstfmE—
Neil King (@NKingofDC) June 24, 2015

EU policies that result in lower interest rates and lower the cost of a sovereign default provide incentives for a government to gamble for redemption.

The interventions taken to date by the EU and the IMF – lowering the cost of borrowing and reducing default penalties, the bailouts and the 50% write-off of the existing Greek government debts – encourage southern Eurozone governments to gamble for redemption.

Greece and a few others are gambling for redemption by betting that the recession will end soon, selling more bonds to smooth government spending in the interim, and reducing the enlarged debt if their economies recover.

If the recession continues for too long, the government will have to stop increasing debt or default on its bonds. Greece has been in default in more than 50% of the time since it became independent in 1822.

A 2014 paper by Kehoe argued that if Germany and France start to get tough with Greece and charge it penal interest rates on further loans and debt rollovers, it will make it optimal for Greece to just default on its government debts and leave the Eurozone.

A resumption in economic growth is one of the few solutions that avoid these calamities.

Greece’s problem is that it is 119th in the 2014 index of economic freedom, just ahead of India. The World Bank ranks Greece 161st in the world for ease of registering property and 91st for enforcing contracts; it takes an average of 1,300 days to enforce a contract through the Greek courts. This low base says something about how Greek politics works and will work for some time to come.

The lengthy shortcomings of the Eurozone were well-known before it was formed. As Michael Bordo pointed out in 1999:

the absence of a central lender of last resort function for EMU, the lack of a central authority supervising the financial systems of EMU, unclear and inconsistent policy guidelines for the ECB, the absence of central co-ordination of fiscal policies within EMU, unduly strict criteria for domestic debt and deficits, as set out in the Maastricht rules, in the face of asymmetric shocks, and Euroland is not an optimal currency area.

Milton Friedman predicted that the Euro would not survive its first major recession.

I told you so is never a solution.

Europe has extensive experience with currency union break-ups:

• The Latin Monetary Union joined Belgium, Italy, and Switzerland with France in 1867. The arrangement held together until the generalized breakdown of global monetary relations during World War I.
• The Scandinavian Monetary Union was formed in 1873 by Sweden and Denmark and Norway joined two years later. This was disrupted by the suspension of convertibility and floating of the three currencies at the start of World War I. The agreement was abandoned during the global financial crisis of 1931.
• Following the start of the Zollverein (the German customs union) in 1834, members established a German Monetary Union. A full merger of all the currencies did not arrive until after consolidation of modern Germany in 1871.
• The only truly successful monetary union in Europe came in 1922 with the birth of the Belgium-Luxembourg Economic Union (BLEU), which remained in force until 1999.
• After the Austro-Hungarian Empire was dismembered by the Treaty of Versailles, in an abrupt and quite chaotic manner, new five currencies were introduced.

Rather than saying the Euro cannot fail, the discussion should be about how the dissolution of currency unions is common, especially where Greece is a member. What happened? What can we learn from the past to prepare for a possible Greek departure from the Eurozone?