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Whether it be countries or individuals, the same economic principles apply.
When expenditures are expected to exceed income, credit is sought to cover the difference. Creditors expect that principal and interest payments on loans will be made in a manner that will insure the ability to pay them off at an agreed upon time.
With governments of countries, this credit is provided by the issuance of bonds that are secured by the full faith and credit of the country’s taxpayers. These bonds are usually sold auction style to investors that are predominantly banks, at a predetermined interest bearing rate based on expected market demand. Thus, the actual auctioned price may differ from the face amount of the bond based on the actual demand. After being auctioned the bonds are usually traded on bond markets where the traded price becomes dependent on general market rates and the considered ability of the country to pay off the bond when it matures.
Thus, countries like individuals must be able to generate sufficient income to cover current expenses, as well as, past expenditures which are represented by these bonds. When governments make decisions to provide future entitlements to their citizens, such as for health care and pensions, unfunded commitments must be met by the collection of accordant taxes or by the issuance of accordant debt. When the interest on the outstanding debt can no longer be met, without violating these commitments, something has to give.
The condition arises where increasing taxes removes capital necessary for growing the economy. Citizens are reluctant to accept necessary cuts in welfare expenditures. Bloated government bureaucracies used to living off of the taxation of the private sector are reluctant to size down and eliminate political patronage.
So what can be done when bankruptcy looms. With individuals and businesses there are laws that allow courts of law to administer the restructuring that is required to return to financial viability. There are no such laws that apply to countries so it must be done by a country’s government and their creditors (bond holders).
The difficulty in the Eurozone (17 countries) is that each country is sovereign but the currency is multi-country. In addition, although there is a European Central Bank (ECB), each country has its own banks that are also bondholders. If a failing country cannot meet the payments due on its outstanding debt the possibility of the failure of banks holding this debt exists.
If each country had its own currency, as existed prior to the establishment of the Euro, devaluation of that currency relative to that of other countries could be utilized in the restructuring of debt. A country doing so would, by virtue of its financial condition, be forced to address its entitlement and taxation policies in order to restore its financial solvency.
Look for the Euro to fail as it logically must. Noted economist Milton Friedman, now deceased, said *"the Euro is going to be a big source of problems, not a source of help. The Euro has no precedent. To the best of my knowledge, there has never been a monetary union, putting out a fiat currency, composed of independent states. There have been unions based on gold or silver, but not on fiat money—money tempted to inflate—put out by politically independent entities."
*Interview with New Perspectives Quarterly Magazine, 2005