Sovereign Debt: Greece and California

I’m afraid I’m about to state the obvious again. Most of you already know what I’m about to say, but as I listen to pundits talk about Greece on daytime TV it’s becoming obvious that not everyone does.

The issue is sovereign debt: when is it a problem and when does it become a crisis? The short answer is that too much debt is, by definition of “too much,” always a problem, whether the debt is owed by individuals, corporations, or countries. Focusing on countries only, too much debt becomes a crisis if the debt is payable in a currency other than the debtor’s currency, or if the debtor has no central bank to purchase its debt, i.e. monetize it.

U.S. debt is a problem, but not a crisis. If worse comes to worse, the Treasury (with the help of Congress) could prevail on the Federal Reserve to buy its debt at prices more favorable than those demanded by foreign creditors. If not sterilized, thus neutralizing the impact of the purchases on the money supply, the Fed would be monetizing the debt and a pickup in inflation would be the likely outcome. Indeed, that is what people mean when they refer to “inflating your way out of debt.”

A developing country that cannot issue debt in its own currency, but must issue it in another currency, say U.S. dollars, must earn the dollars necessary to service and redeem the debt through foreign trade (or perhaps temporarily through foreign borrowing to roll the debt over). It does not have the luxury of borrowing from its own central bank to service and redeem the debt.

Since Greece is one of 16 members of the Euro zone, its position is very much like a state in the United States. The European Central Bank is its central bank, but Greece cannot force it to monetize its debt. Likewise, California shares its central bank with 49 other states and cannot force it to buy and monetize its debt. Just as Greece has to earn the Euros it needs, so must California earn the dollars it needs.

Of course, none of this comes as a surprise. Countries knew they were giving up monetary independence when they joined the Euro-zone and that monetary policy would be determined by a central bank serving all its members collectively rather than individually. Consequently, these countries cannot indefinitely delay paying the piper – a positive outcome. For individual states, maintaining a balanced budget is likely just as constructive.

Of course, California is a larger percentage of the dollar zone than Greece is of the Euro-zone and is more likely, eventually, to be treated as too big to fail, not by its central bank, but by its federal government. Since the dollar zone has been around a long time and states (except Texas) don’t have the option of dropping out, California will likely have less leverage with its federal government than Greece has with the European Community. So far, the Europeans have been gathering to decide how to help even before Greece has asked for any help. That’s pretty responsive, if you ask me.

Comments (7)

Trackback URL | Comments RSS Feed

  1. RK says:

    Are you being facetious about Texas having the option to drop out? I can’t tell. I have never heard of this fact.

  2. Bob McTeer says:


    I was being semi-facetious. It’s not something I’m advocating, but I understand that since Texas was an independent country when it joined the United States, the treaty terms did permit it to change its mind and secede. There was also something about its ability to break itself up into multiple states, I believe.


  3. Kenneth Artz says:

    I propose that if the Obama Administration deems California “too big to fail,” it should admit that it is also “too big to succeed.” Then we can test the efficacy of Joe Biden’s plan for Iraq and divide the Golden State into three separate entities, each ruled by a different special interest group or tribe.

  4. W.C. Varones says:

    I understand that since Texas was an independent country when it joined the United States, the treaty terms did permit it to change its mind and succeed.

    That’s a Freudian slip if I ever saw one!

  5. Joe Moore says:

    California has already received the favor of the monitization of debt by means of “stimulus” and omnibus, to what degree is unknown.

    Lavishly entitled pensioners and wreckless debtors, in CA and elsewhere, will continue to wield incestuous leverage with US monetization and borrowing efforts if sensible people don’t work to expose and stop this insidious conspiracy, Bob.

  6. Pedro says:

    Not sure why you believe you can simply inflate your way out of debt? Doing so would cause the buyers of your bonds to demand higher rates or worse still – countries like Japan and China could simply dump their US holdings. Hyperinflation would be the result. I think California’s problems are significantly more problematic than Greece’s. Greece is small enough to actually get bailed out with out serious impact on the Euro. Can the same be said about Cali and the dollar. If you are looking for a safe haven currency…Norway is most probably a good bet.

  7. Karl Duross says:

    Germany, only a short time ago, raised the retirement age to 67, while Greece lowered the retirement age to 58. About the same time riots in Greece by students and Union members had the country about to implode. If anyone rioted it should be the Germans who are going to have to foot the bill because for the most part it’s the only county keeping Europe afloat. Soon Portugal and Spain will be in almost the same boat as Greece. Not long after that Italy is about to fall. If the Italian economy fails look for the Northern League to secede leaving the southern half of Italy to fend for itself.