The concept of compound interest can be insidious. I believe the terminology “compound interest rate” is misleading; it is helpful to look at the financial obligations as the “doubling time”.

The doubling time is often estimated by the Rule of 72, and somewhat more sophisticated calculations, namely:

A good example is to use the latest data from CNN on the Davos 2012 conference. Here are the compound interest rates for the respective bonds (aka the “yields”), and the length of time it takes for the amount owing to double:

One can calculate an arbitrary doubling time on Wolfram Alpha.

In other words, with some hypothetical numbers for simplicity, if Greece owes $1 billion today, in a mere 28 months it would owe $2 billion (presuming the state borrows at this rate to make its interest payments). In 56 months, it would owe $4 billion. In 7 years, it would owe $8 billion. If Greece owes 100% of GDP today, then in 8 years it would owe 800% in 7 years. At the same time, with economic catastrophe hanging over its head Greece shall experience negative growth. Clearly this divergence is unsustainable, given that most developed states rarely enjoy growth rates greater than 5% (I.e. doubling every 14 years) and often less than 3% (I.e. doubling every 24 years).

To put this in simplistic but tangible terms, the cost of apples shall double in Greece every two years, yet assuming an optimistic 3% growth wages will double every 24 years (the growth in Greece is actually -5.5% at the moment, meaning wages in aggregate shall be decreasing).

The Sovereign Insolvency World Map is a work in progress. Improvements that I would ideally like to see included in the page someday include:

• More comments on the specific defaults, including amounts and related politics and socioeconomic events (causes & effects)
• A “source” linked to every default that indicates the source for our knowledge about this default
• The ability to select a range of years where defaults have occurred
• Different colours depending on the “era” in which default occurred, or whether it was a foreign or domestic default
• The addition of banking defaults and other financial crises (eg recessions)

The Sovereign Insolvency World Map web-page, source code and the related data in the spreadsheet are published under the Creative Commons Attribution 3.0 Unported License so that others may fork and build upon it. The source for the application is available on Bitbucket.org.

I have been following the Greek crisis and have posted a significant number of the news articles regarding Greece to my Twitter feed (which is linked on this page).

Philip Wood, head of the Global Law Intelligence Unit at Allen & Overy, has sent me a paper with their analysis of this question, entitled “The euro and currency unions” dated October 2011.

If you are curious about how Greece might leave the Eurozone, or what may happen, this paper is a superb analysis. Here are a few choice quotes:

The withdrawal of a member state from the euro or the collapse of the euro itself, if it ever happened, would be a major event which one would expect to be dealt with at the political rather than the legal level. Nevertheless, we summarise the technical legal position, however theoretical, because strict legal rights, even if never exercised, are an important factor in determining bargaining positions.

(emphasis added)

Cessation from the Eurozone treaties was left intentionally left vague when the treaties were negotiated, so there is no way for Greece to legally leave (though the paper notes that they may do so after two years or alternatively with a 72% vote of the European Council under article 50 of the Treaty of Lisbon):

The European treaties are vague on the subject of member states leaving the euro. When the treaties were negotiated, it was felt that explicit rights of withdrawal might damage confidence in the new currency. So there is a legal vacuum which has to be filled by implications and inferences, thereby leaving room for differences of opinion.

There are no explicit legal rights to expel a state from the EU or the eurozone.

That being said, a treaty is only as enforceable as the consequences of breach:

A treaty is just a contract and contracts do get broken. The question therefore is what the legal position might be if a eurozone member unilaterally decided to withdraw from the eurozone in violation of the treaty and to create some new currency at a specified rate of conversion.

…

The reality is that one can forget about legal rights against a member state which unilaterally withdraws in breach of the Eu treaty.

A country such as Greece can breach its obligations under the treaties establishing a euro currency zone and issue its own currency. Although the legal consequences are limited, the political and financial consequences would be dramatic.

Among many other points, the article notes that Latvia chose not to depreciate its currency peg to the Euro, but rather opted to decrease wages and public spending – i.e. austerity. Greece, on the other hand, is facing large public and political fallout because of its proposed austerity plans.

It’s worth quoting the conclusion:

[Even though Latvia is growing its relationship with Russia and support for the EU is very low], Latvia looks good when compared with Greece. It did not lie about its public finances or use accounting tricks. Strikes have been scanty. Protests are fought in the courts, not the streets. Both Greece and Latvia have had hard knocks, but Greeks became used to a good life that they are loth to give up. Latvians remain glad just to be on the map.

The formula isn’t given, but they’ve provided a chart indicating the results of their application of the formula:

Their formula ranks as the highest risk of default (in decreasing order) Ireland, Greece, Portugal, Britain and Italy.

This RBC risk evaluation formula, the details of which I don’t know, is an alternative to the formula for evaluating risk that I recently conjured. The RBC formula seems to involve more factors than my simplistic equation, though since we don’t know the formula itself we’re left to speculate.

My formula, the “future going burden” as I’ve coined it, is:

Future going burden calculation

The risk of such a bailout is the moral hazard: sovereign debtors in the Eurozone can take more risk without fear of default because the sovereign can count on others in the Eurozone bailing them out; and concurrently creditors can take greater risk (over)investing in Eurozone sovereigns on the basis that their investment is insured by other sovereigns who would intervene with a bailout to avoid a run on the Euro.

The risk of not bailing Greece out is contagion, as per the article:

The BBC’s economics correspondent Andrew Walker says a default by any of the high-deficit eurozone countries would hit banks in Europe which hold government debt. The risk is that the contagion could trigger a rapid decline in the euro’s value, he says.

Latvia and other Baltic countries received bailouts from the IMF when their public institutions became insolvent during the credit crunch in 2008-2009. Latvia suffered a dramatic 24% shrinkage of its economy over the crisis (which, the Globe & Mail notes, is greater than that of crisis of the U.S. during the Great Depression).

Some of these Baltic countries peg their currency (and some of their debts) to the Euro. Some economists argued that rather than a bailout the countries should have revalued their currencies. The article notes:

“It makes no sense to continue to shrink the Latvian economy, with no end in sight to the recession, simply to maintain the pegged exchange rate,” agreed [Mark] Weisbrot. “Argentina tried this from 1998-2002, also suffering its worst recession ever and pushing 42 per cent of its households into poverty.”

The Baltic governments and central banks argued devaluation – which would be a ‘nuclear’ option for faltering euro zone members – would cause more harm than good, due mainly to high levels of debt in euros run up during the boom.

As a result, Latvia is set to see a 2009 fall in economic activity of 18 per cent and Estonia around 14 per cent. Lithuania has reported a drop of 15 per cent.

The article talks about some of the effects of the austerity:

But by and large you don’t see the poverty in the Baltic capitals, where the streets still buzz with activity, and popular cafes and restaurants are often full.

It’s the suburbs that can show most how property and construction, shops, restaurants and car dealers have been really hit.

At the Saliena property project just outside Riga, sales director Barny Edis points to empty, unsold houses. The ground is still muddy; pipes and construction material have been left lying around. Evidence of the past boom is down the road, where 200 houses that did sell are still occupied.

“It is tough. It’s been tough for me, it’s been tough for my family, but what doesn’t kill you makes you stronger,” said Mr. Edis, a Briton who brought his wife and two children to Latvia in 2007, just before the property bubble burst.

One pithy quote: “The crisis could be felt in many spheres, he said: People had to realize that to find a job they had to bring down their expectations of how much they could earn.”

The effects of a sovereign insolvency, such as those described above, are important to considering how to mitigate the immediate, short-term and long-term harm of the crisis.

The austerity program calls for, among other things, a wage freeze and raise the average retirement age from 61 to 63 in 2015 (to reduce costs to the pension program).

The basis for the strikes, according to the BBC, is the broad belief that:

1. The crisis has been caused by speculators and European central bankers;

2. The rich are dodging taxes; and

3. The austerity program is an affront to the working and middle class.

These strikes come shortly after Germany led a movement to bail Greece out, according to the Globe and Mail.

The Globe and Mail has an article on the effects of a Greece insolvency on the rest of the world, namely a threat to the euro, a domino effect, and capital flight.

According to my formula on the forward going burden, per my post Greece vows to reduce debt, the UK has the second-highest burden only after Greece.

That being said, the UK is a financial hub with much expertise, it has its own currency, a history of fiscal stability, a many significant assets, and reasonably transparent policies. While it may rank very high in the forward going burden the United Kingdom’s risk is offset by these factors – at least for the moment.

According to the article Portugal’s debt as a percentage of GDP is 85%, and its deficit as a percentage of GDP is 9.3%. According to the formula I created in my post Greece vows to reduce deficit, Portugal’s “future going burden” is 4.73, well below the UK (5.75), Greece (5.81), and Spain (5.12).

Although Portugal’s forward going burden is not high, countries in the EU are being categorized as higher risk because of the potential of a default by Greece. By being so-categorized, Portugal’s risk of a run is higher (thus so is the likelihood of insolvency).