Ways out of debt

  From previous post, I got a conclusion that high leverage ratio is harmful to a country’s economy. However, how can a country get rid of high indebtedness?

  (I). The simplest way of debt reduction is direct default. By refusing to pay back the debt, the debt will just disappear. Besides,by only paying part of the debt (eg. the principal) and refusing to pay the interests, the debt level will be decreased. Although many people believe that Greece will inevitably default on its sovereign debt. Still Greece should attempt to avoid default, because the cost of default is enormous. If Greece defaults on its sovereign debt it may have to leave the euro zone and the shocking impact of it is unpredictable. What's more, Greece had a default history before. By doing this again, Greece’s credit may be ruined, making it hard or even impossible to borrow from other counties in the future. So default should not be a proper solution to lower debt level. On the other way, avoid default should be an aim together with shrinking indebtedness.

  (II). Inflation, which can be regarded as an indirect form of default, is an easy way to create solvency. For Greece, unless quitting from euro zone, its currency (euro) will not depreciate just because of its demand.

  (III). Debt restructuring is the most widely used way to bring down debt in the past few decades （2011, Reinhart and Rogoff, a decade of debt. Debt restructuring can be implemented in several ways: debt swap; controlling interest rate; exploit captive domestic audience (eg. pension funds) to buy government bonds. In Greece, Debt swap is already on the way. To exchange for bailout, Greece parliament has approved a bondholder haircut deal that forces private sector bondholders to suffer a loss of 53.5% on their bonds on 23rd, February, 2012. Unfortunately, as a member of the euro zone, Greece cannot control the interest rate solely, so the second approach is not feasible. As for the third approach, obviously it will severely harm Greek people's benefit and make the government lose the last support. According to what Evangelos Venizelos (Finance Minister of Greece) said recently, Greece pension funds currently hold €1.2 billion government debt. He promised government bond will be replaced by more profitable and reliable investment. Therefore, as far as we know now, the government will not take this step in the foreseeable future.

  (IV). Austerity policy is also a prevalent way to help repay debt. It relies mainly on cutting spending and raising tax. The same with debt swap, it is also a requirement from the other euro zone countries to provide bailout. At present, Greece is continuing to enforce an austerity package such as lowering minimum wages, cutting education budget.

  Under the purpose of  lowering debt level and avoiding default , we can see that the only possible ways to decrease debt are debt swap and austerity policy. Apparently austerity policy is plays a more important role in debt reduction and it is more comprehensive. I will emphasis on how the austerity will affect the economy in the next post.