If EU Countries Default, How Will the U.S. Be Affected?

BY Business Desk  February 9, 2010 at 9:41 AM EDT

Question: If the EU PIGS (Portugal, Ireland, Greece, Spain) default, how will this affect the United States?

Paul Solman: First, it should be PIIGS. Add an “I” for Italy. Or, if you want to call it PIIIGS, you can add an “I” for Iceland to your quartet of what, from a creditor’s point of view, might now be called the Euro-trash.*

Second, what’s a “default”? Technically, any change in the contract of a debtor. So if I do a loan remod(ification) on my house because I can’t afford the payments, that’s a default: The value of the mortgage my creditor owns has gone down.

The external debt of the PIIGS is several hundred billion dollars — money borrowed by their governments and owed to foreign investors. How much of that will vanish in a series of defaults? And is such a thing implausible?

Well, Iceland’s people are actually VOTING on a government plan to repay creditors on March 6 and could decide to stiff them. Greece has been lying to its fellow members of the EU about its true debts — understating them in hyperbole Homer couldn’t top. Greek public workers are holding a national strike Wednesday to protest proposed budget cuts. Oh yes, and Greece, as Carmen Reinhart and Ken Rogoff have pointed out, has been in default in HALF the years since WWII.

And that’s just Greece and Iceland. If they and their fellow ‘swine’ were to default on their “external debts” — money owed to lenders who don’t live in their countries, that is – we could again be on the brink of a worldwide credit freeze. That can’t be good for anyone, including the United States.

I haven’t used this chestnut in months because I haven’t had to, but remember, credit comes from “credere” — to believe. A debtor who loses credibility loses the ability to borrow.

On the other hand (with apologies to Harry Truman), where else are you going to put your money if Europe seizes up? Back in U.S. Treasuries, perhaps? Which will strengthen the dollar and could LOWER the interest rate the United States has to pay to borrow money from abroad. Odd, isn’t it?

As Yale historian Paul Kennedy put it to me yesterday for a NewsHour interview that should run soon: Which would you rather have: a stable world and a weak dollar or a jittery world and a strong U.S. currency?

UPDATE: I’m updating this answer as I learn more about the situation in the PIIIG pen. This just in from MIT’s Simon Johnson:

Most of their debt is in euros; who holds it is not clear – a lot is likely in their own banks at this point. The global financial disruption scenario is through CDS (again); who has insured this debt? The pressure for a euro bailout will come from their banks.

(For what Simon means by “CDS” — Credit Default Swaps — see our piece, mocked amiably by Jon Stewart but accurate nonetheless.)_

*Editor’s note: This paragraph earlier left Italy out of the PIIGS acronym and has since been updated.