In the current crisis there is one small detail that risks being overlooked. It is the unavoidable law of nature that all debts will be paid, always. The only issue being discussed is who will pay these debts.
In the case of an individual, or a company, there are only two possibilities: either the borrower pays his debt (as agreed at the time of borrowing) or he does not, in which case the lender ends up paying all or part of the debt. The issue then, in any renegociation, is agreeing terms for a shift of the burden back to the lender. Usually this happens because it is in the interest of both parties to do so (demanding full payment may lead to forced assets sales from the borrower, which may affect his future earning ability - if he sells his car he cannot travel to work., etc etc).
In the case of a country (of sovereign debt) there are three possibilities.
The borrower pays (as agreed). Why is this a problem? If the debt was accumulated for consumption or unproductive investment (such as specialization in non-tradables, that is: construction) the debt burden can become too high. This happens when interest on the debt exceeds the growth rate of income per capita. This situation is more likely when an economy enters a recession of course. Having to pay a high debt burden then further increases the recession and may even lead to a bigger debt burden. The issue here is whether paying off aggressively, and going through a deep recession but reducing the debt burden will allow the economy to get out of this economic trap. Ireland seems to have chosen this route successfully. The problem then is the the current recession in Portugal is not deep enough to get rid of the debt.
This first scenario of course raises strong emotions if the lender is a rich country (tipically the case), so that it has a flavour of rich scandinavians being insensitive towards the troubles of poor southerners.
The lender pays. The lender (remember) has already paid it when he loaned the money in the first place. Default just means that money is gone and that part of the debt has been paid. In this scenario, the rich scandinavians lose part of their pensions. But since they are rich we tend to worry less about whether that is right or wrong. But there is a catch. If banks in Germany are exposed to a default on Portuguese sovereign debt, then a large default may undermine the German banking system which could lead to a much bigger crisis on the European scale. That is why Europe resisted so long to accept a Greek default: to give time for private agents to write off part of their bad assets in an organized fashion, without risking financial collapse. So, making the lender pay, at least pay a lot of the debt, may not be such a great idea after all.
There is a third way. To inflate the economy. Printing money is a time-honoured way of getting rid of debts governments cannot pay by raising taxes. In this case EVERYONE pays. By inflating the economy the value of money (the amount of goods money can buy) is eroded for everyone, which makes it the most democratic (because it is absolutely proportional to money holdings) way of solving the problem.
Here the catch is that Portugal does not have the finger of the printer. The Germans do. And they do not like this idea. We cannot blame them since we would not like it either if the situation was reversed.
There is an even bigger catch. It is called Moral Hazard. In both cases where either the lender pays, or the printer is used there is huge Moral Hazard. We cannot forget this is a repeated game. It is not a surprise then that most Germans may be willing to pay a price to see the Greeks and the Portuguese suffer. They are likely to see it as the necessary punishment to make sure this never happens again. The sad thing is that they are most likely wrong: this WILL happen again.
One final remark in the sovereign debt saga affecting Europe is that there is a strong mistrust and antipathy towards the Troika. People are angry about a perceived loss of sovereignty. But this is a run of the mill consequance. When firms or individuals go bankrupt, creditors take over the business and run their lives. Why should countries be treated any different?
Consider the problem of Portugal for example.
