Greece and the Eurozone’s fork in the road
The Euro was the pinnacle of a dream – A dream of European unity, and commitment to a shared economic future, based on a common agreed set of principles about fiscal discipline and free markets within the Eurozone. Critics have waxed lyrical about the fundamental contradictions inherent in maintaining various national treasuries while having a common central bank since its inception. But here in the first week of May 2010 it is protesters on the streets of Athens and politicians in the Bundestag in Berlin who face the very real prospect of ending the dream.
So many issues are converging on the Euro that’s its ability to remain as a transnational currency must surely be in question.
Recession all Greek to the Greek’s
First up is the Greek debt. The $143 billion package put together by the IMF and the European nations – at their third attempt – covers about a third of Greece’s debt. But that has taken the IMF well outside its standard limit, and the ability of Germany is dependent on political agreement there, with the prospect of a legal challenge testing the ‘No bail out’ provisions needing to be squared away.
The cost to Greece is the certainty of the toughest economic 5-10 years in the living memory of any Greek. That’s why they are on the streets protesting. They know that they are being made to pay. It’s their bonus’, their services, pensions, and their jobs. Greece is looking at a GDP contraction of 11% over three years, in order to bring the budget deficit back to 3% of GDP in that time. Primary debt to GDP currently stands at least at 8.5%, and even with the bailout public debt will likely peak at 150% of GDP. Restructuring debt of this magnitude is going to be the last word in painful. You have to ask why anyone would opt for this, the same as ask what other remote alternatives are there?
This basically adds up to a bailout package which will probably get up, but may not actually restore the Greek debt situation to something more manageable, and is probably unlikely to be politically tolerable for long in Athens.
But even if you assume that the bailout can get up and the Greeks can knuckle down to half a decade of recession, and the markets can still see their way clear to handling funding for an economy floating face down in the Aegean, there is still further issues, and they make for equally ugly viewing. It takes just a brief look at 10 year bond yield spreads on Portuguese, Irish, Spanish and Italian debt against their German counterparts to come to the conclusion that they could, oh so easily, be the next cabs off the rank.
This leads to further problems. The funds put together for a Greek bailout now can’t be used for further bailouts later on. This in turn raises the question of how much bailing out can actually be done, against how much is potentially needed. Any remote thought that there will be problems in any of those countries, and that there will be problems finding something in the kitty for them will see their debt service capability turn to ash, in the same way Greece’s has, with the same spectre of default or EU/IMF imposed recession hanging over them. Their budgets are generally better than Greece’s, but not by enough for anyone to take their eyes off the ball, for their debt servicing ability is febrile if costs rise. More to the point, their protests that they aren’t in the same category as Greece are increasingly whispers into a gale of negative sentiment, and the moves by ratings agencies to downgrade their debts haven’t helped. If they find themselves anywhere nearer to the Greek situation than they currently are, then presumably they will find themselves eyeing the prospect of similar austerity measures to those generating crowds in Athens this week.
Germany is central to any bailout role for Greece, with Chancellor Angela Merkel throwing down the challenge to the Bundestag by noting “Europe is looking to Germany today,” and adding, “Without us, or against us, no decision can be taken.” She isn’t wrong, and if anything she is understating the magnitude of the problem when stating “This has enormous consequences for Germany and for Europe.”
German politicians and voters are understandably reticent to step up to fund what they see as profligacy of their fellow Euro members. At the moment it is Greece reliant on considerable billions in German generosity, but the prospect of more bailouts coming down the road appalls those on the streets of German cities, making the process of voting up support for them in the Bundestag less than a foregone conclusion, and even if that gets up there could still be the possibility of a legal challenge. It is only last year that a constitutional ammendment was passed limiting federal borrowing to less than 0.35% of GDP as of 2016. There’s a lot of political capital on the line, and a lot of Germans increasingly asking if it wouldn’t be easier simply to go back to using the Deutschemark.
Banking on hanging together
The traditional response would be a default by the nations in question. Creditors take however many cents in the dollar they can get, the currency dives, and then whatever industries in place start rebounding on the back of the relative cheapness of the devalued currency. They can’t do that at the moment because they are all part of the same currency, the Euro, meaning they don’t get a U-turn effect from a currency devaluation.
At the same time their capacity to spend to generate economic growth is curtailed by strict limitations on the size of budget deficits. Admittedly these limitations which have been well and truly fudged with credit default swaps and derivatives in order to allow some of these nations to gain access to the Eurozone in the first place – the genesis of the current crisis – with the currently spiraling yield spreads on their sovereign issues, and CDS spreads, the best indication of how the markets, which enabled them to do the fudging, rate their ability to live with it.
But the major spectre behind the possibility of a departure from the Euro and/or default of any of these nations, is the impact this would have on the European banking system. Ever since the creation of the Euro in 1995 major European banks have made lucrative returns from sovereign debt of the Club Med nations. That means they are now so exposed to them that any defaults on their part would be little short of calamitous.
The debt feast
Citigroup analysts have recently estimated total European banking exposure to the threatened Euro nations (sovereign and private) at €2.3 trillion, with German banks having about €615 billion and French banks €700 billion. While Greece is the recipient of about €200 billion in loans from these banks, Ireland is in for €460 billion, Spain €700 billion, and Italy €770 billion. The Bank for International Settlements puts the exposure at mildly less alarming but still major levels. Individual banks are understandably reticent to disclose too much. Most of the larger European Banks and financial institutions have major exposures – Deutsche Bank, Commerzbank, Munich Re, Hypo Real Estate, AXA, ING and so on.
Any reversion to national currencies or defaults on the part of the debtor nations would see these loans overwhelm servicing capacity, with mammoth holes in the balance sheets of these institutions the next logical step – and presumably more calls for state assistance in handling it.
Hindsight is a wonderful thing, but unfortunately less than useful. What wouldn’t the financial officials who signed off on the entry of Greece, Spain, Portugal, Italy and Eire for the chance to look at the books one final time before giving the final OK?
Somehow the Eurozone needs to conjure up a credible escape mechanism for the debts of its most indebted members, while keeping them inside the club. The Greek bailout package doesn’t look credible for Greece, and the manner of getting it together doesn’t bode well for the possibility that other Club Med nations may find themselves in a similar position. Either way the current outlook seems to envisage economic stagnation in certainly Greece, and nearly certainly other debtor nations inside the Euro. And should these be managed in a way as to enable everything to hang together, then certainly the entire euro concept will need to be gone over again with a view to having a game plan for when these crises unfold. But for the time being hang on – for the mess is a long way from sorted. What is on the table won't work, and time to find something that will is running out.
Business RT: James Blake