Creditflux Newsletter

Greece may or may not default this year, but we can be sure that sooner or later a eurozone country will do so. Default is a normal – if rare and messy – part of the credit business. Borrowers often try to borrow more than they can afford. Sometimes, investors are daft enough to lend it to them. When the borrower’s debts become greater than they are able or willing to pay back, then default is the natural consequence.

For countries, the complicating factor is that many issue their own currencies and raise much of the finance they need in that currency. And in those cases, default is often disguised as a devaluation.

But this is a fairly recent phenomenon. For most of history, countries have borrowed in currencies, such as metals, that they could not create – unless, like Golden Age Spain, you were lucky enough to own a big silver mine. True, rulers could debase their coinage, but that sleight of hand bought only a temporary respite for a struggling sovereign.

Lately, there has been a gradual move back towards countries using and borrowing in currencies they do not print. This is because many governments have slowly realised that their countries can’t sustain a credible currency without a sufficiently deep domestic capital market to meet their financing needs.

The launch of the euro in 1999 is just one part of the slow global retreat from sovereign currencies. Around the same time, a few small developing countries dropped their own Mickey Mouse currencies and adopted the dollar unilaterally. El Salvador was a trailblazer in 2001, along with Ecuador, which adopted the dollar as its currency following one of its many defaults.

But one country has been in this currency-less position for its entire history. Panama has never had its own peso or colon or boliviano. It has always used the greenback – the currency of the country that carved it out of Colombia in 1903. Life without a printing press has not always been good for Panama, but lately it has been doing very well. All three rating agencies view it to be within a whisker of investment grade.

Greece has a lot more in common with Panama than it does with California – that other overburdened borrower to which it is often compared. Both Panama and Greece are small, open economies with a big dependence on shipping.

Unlike California, which is an integral part of the entity that issues its currency, Panama does not have a shred of influence over the Federal Reserve. The same will prove to be true about Greece’s role in the eurozone – eventually.

Greece has a reasonable chance of getting some kind of bail-out now because its neighbours are terrified of the consequences of a default, and the possibility of Portugal or Ireland following it down.

Yet history, such as the Asian crisis of 1997, shows that a Greek default would indeed make waves, but that stronger countries would succeed in turning the tide. European countries have big problems but they are not a house of cards: they have real assets and earning power. Most of them can pay all their debts. And all of them can pay most of their debts.

A bail-out, on the other hand, would make it almost inevitable that weaker credits would continue to borrow more than they can afford. Ultimately, voters in Germany will be as unwilling to support profligate public spending in Greece or Portugal as US voters would be to prop up a small Latin American country.

Greece has more debt than it can afford and it should get on with restructuring it. And sovereign bond investors should never forget that they are credit investors.