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Archive for Friday, April 30, 2010

Greece’s debt troubles raise contagion worries

April 30, 2010

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— The Greek debt crisis sent a shudder through global financial markets and served as a reminder of how vulnerable the world economy remains to the threat of a financial panic.

To many, market developments this week served as a spooky reminder of the fall of 2008 and the panic after Lehman Brothers collapsed in September 2008.

“If people get scared that Greece could default, they are going to be scared that Portugal will default and then other countries. Once people panic, they panic about everything,” said David Wyss, chief economist at Standard and Poor’s in New York.

European and Germany officials have sought to assure investors that they were working quickly to approve a bailout for Greece with European Union monetary affairs commission Olli Rehn, saying he was confident that talks on a bailout package of support from European countries and the International Monetary Fund would be wrapped up in a few days.

The White House released a statement late Wednesday that President Barack Obama and German Chancellor Angela Merkel had discussed the “importance of resolute action by Greece and timely support from the IMF and Europe to address Greece’s economic difficulties.”

In Asia, while there are not yet significant concerns about the governments’ creditworthiness, big economies like China and Japan still have much at stake. Europe is an important export market for Asia, and China and Japan are among the biggest investors in the debt issued by the United States and European countries with holdings worth billions of dollars.

There are also concerns the turmoil in Europe could convince China to delay any appreciation of its currency — widely viewed as undervalued — aggravating tensions with the U.S. and other trading partners.

Economists noted that the debt problems in Greece and other European countries often occur after a financial crisis. Governments borrow heavily to prop up their banking systems, which sends their debt burdens soaring.

The United States has seen its publicly held debt jump from 36 percent of the total economy in 2007 to 64 percent this year. That’s the highest level since 1951, when the country was paying off the debt run up to fight World War II.

Debt levels of all developing countries are rising to levels not seen over the past 60 years, the IMF said in an economic survey released last week.

“Governments used their resources to end the financial panic and the Great Recession,” said Mark Zandi, chief economist at Moody’s Analytics, “but now they have to figure out how to pay for it.”

Comments

barrypenders 3 years, 11 months ago

With the Spanish — and Portuguese and (another) Greek — downgrade, we firmly believe that Wednesday is the day when it became unavoidable to consider that the eurozone could end as a functional union. At this point, there are too many variables to try to forecast whether markets will indeed be shocked and awed by Europe’s bailout, or what specific route the degradation will take from here. But this remains a central issue. The point is, whether Europe wants to pay for a Greek bailout is now not the question, because the truth is that Europe may no longer be able to come up with the necessary resources to do so. This prompts STRATFOR to ask a new question: Who else might join Greece in default, and how long does the eurozone have before the Fates cut its thread of life?

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barrypenders 3 years, 11 months ago

First, the eurozone has 16 political centers of power, and what agreements they have are based on treaty law. Deviating from that law requires not simply running a bill down to Congress, but submitting it to 16 — and in many cases 27 — different executives and legislatures, and likely a handful of popular referendums as well. Second, the ECB cannot intervene directly in government debt. Sections of the treaties that established the EU simply deny that option to the bank. Third, due to the limitations of the second point above, to pay for the bailout, Europe would need to tap international bond markets — or national taxpayers — when skepticism of the euro is at its highest since its inception, and a recession is stubbornly keeping that skepticism from being dispelled. Nobody is looking to Europe’s bonds as a safe-haven from financial turbulence, and its own people are not exactly cash-rich these days. Fourth, and most important, the eurozone is acting in an ad hoc fashion as each crisis develops. But the reality is that the crisis is happening at this very moment, and evolving quickly, especially with risks to the rest of Club Med. Furthermore, the sovereign debt crisis is only obfuscating the equally dangerous crisis of Europe’s private financial sector (its banks), which has still not come full circle. Having ignored the opportunity to enact a “Band-Aid” bailout in February or March — and having no monetary policy capable of directly intervening in the crisis –- Europe is left trying to enact a “shock and awe” bailout of roughly 100-150 billion euros along with the IMF. Shock and awe in that supposedly such a big program would hit those doubting Europe so hard that it would coerce the global system into believing that Europe was just fine. If that does not work, Europe may be forced to consider raising roughly half a trillion euros to rescue the Club Med economies, which we believe will be politically unpalatable and perhaps financially impossible because it would force Germany and other eurozone member states to enact austerity measures Greece has been unable to enact. And in the extraordinarily unlikely circumstance that the Europeans could find that sort of cash, it is worth noting that even 500 billion euros is only about a fifth of the outstanding debt of Club Med — much less of the eurozone as a whole.

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barrypenders 3 years, 11 months ago

Let us for a moment consider what contagion from the Greek crisis means for Europe. Greece in and of itself is a tiny segment of the EU economy (accounting for only 2.4 percent of the eurozone economy). If the crisis spreads to Italy and Spain via financial markets’ pessimism, it would engulf the third- and fourth-largest eurozone economies. At that point, a “bailout” of the eurozone would become a task worthy of Homer’s epics. Dealing with such a dramatic scenario is beyond the powers of the eurozone. To illustrate this point, let’s turn to the example of the U.S. financial sector bailout following the subprime mortgage-induced financial crisis. The United States acted with relative speed –- considering the level of political uncertainty in the midst of a presidential election –- and determination. The resulting bailout packages, capped with the much politicized $700 billion for the Troubled Asset Relief Program, ultimately saw the United States commit up to $13 trillion worth of lending and guarantees for a broad array of financial concerns (of which about $4 trillion was tapped). But the United States had four factors on its side. First, it has a sole center of political power –- the U.S. federal government –- that allows it to make and implement decisions without consulting other “member states.” Although clearing the hurdle of the U.S. Congress is no small matter, it is nowhere near the task of clearing 16 (and sometimes 27) countries, each with its own legislature and legal challenges. Second, the United States has independent control over its monetary policy through the Federal Reserve, which allows it to address problems with an array of tools. Third, Washington tapped international bond markets to pay for all this debt-financed spending in the midst of a gut-wrenching global recession when every investor (and their proverbial mother) was looking to get out of risky emerging markets into what they perceived as the safety of U.S. Treasury bills. Fourth, the first and second points above allowed the United States to act before the crisis developed into something much worse. While it certainly did not feel like it at the time, the United States had the advantage of time. Its financing issues were not dependent upon the vagaries of international bond traders; Europe’s are. As a counterexample, the scope of Europe’s problem is far larger, and the tools to address it are lacking.

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barrypenders 3 years, 11 months ago

THURSDAY, APRIL 29, 2010 STRATFOR.COM Diary Archives

Greek Tragedy: Point of No Return?

HEADS OF KEY INTERNATIONAL ECONOMIC INSTITUTIONS including the Organization for Economic Cooperation and Development, the World Trade Organization, the International Labor Organization, the World Bank and the International Monetary Fund (IMF) met with German Chancellor Angela Merkel, European Central Bank (ECB) President Jean-Claude Trichet and German Finance Minister Wolfgang Schaeuble on Wednesday in Berlin. The meeting was crucial for the financially embattled Athens, which — as with every Greek tragedy protagonist before it — no longer has control of its own future, and looked upon the Berlin summit as a meeting of Olympian gods deciding its fate. It was therefore puzzling that the joint statement following the Berlin meeting did not mention Greece at all, instead touching upon broad subjects ranging from the Doha Development Agenda to the need to fight poverty and climate change. Perhaps in the context of ongoing indecision by the eurozone — and Berlin in particular — to enact a financial aid mechanism for Greece, the lack of clarity from the meeting in Germany should come as no surprise. It continues a trend that started in January of Europe hosting meetings that conclude in statements that are read, filed away and promptly forgotten. But something else happened on Wednesday that set alarm bells ringing in capitals across the European Union. Credit agency Standard & Poor’s (S&P) downgraded Spain’s sovereign debt rating by one notch to AA. This was the third downgrade by S&P in two days, following Tuesday’s downgrades of Portugal (by two notches) and Greece (by three notches). The downgrades illustrate a clear and firm vote of no confidence by the markets for the economies of Club Med (Greece, Portugal, Spain and Italy), and indicate the risk of contagion from the Greek crisis to other, larger members of the eurozone. Whether the macroeconomic fundamentals of Club Med support such pessimism or not, the perception of the markets has now become the region’s reality. The failure of Germany and the eurozone to nip it in the bud has potentially allowed the Greek imbroglio to blight the whole European project

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barrypenders 3 years, 11 months ago

Break Points

Debt rollover. Greece must raise 8.5 billion euros by May 19 to cover long-term debt that comes due that day. Before the euro, when Athens controlled its own currency and was not flirting with default, the borrowing rate was 13-16 percent, so given the way Greece’s borrowing costs are rising, the April 21 rate of 11 percent is only the beginning. Unless the European bloc and IMF agree to a concrete aid package beforehand, May 19 is almost certain to push Greece into default. And even if it manages to avoid catastrophe, more debt will come due in the near future. Normal spending. The May 19 deadline is a rollover of past debt — money already spent. That does not keep the lights on in Athens today; it is paying for the loans that kept the lights on in years previous. Greece is so far in debt today that it in essence lives hand-to-mouth. It needs daily access to debt markets to keep the government running, and now that it has formally asked for financial assistance — which will not immediately materialize — the cost of raising money is rising by the hour. It is very possible that Athens will not be able to find buyers of its bonds at any price, which could make the entire Greek government halt. This may sound somewhat alarmist, but consider that this is precisely what happened in Argentina in 2001, and the Argentine population was much less coddled than the Greek population. So the anarchy in Buenos Aires was probably less intense than a Greek reaction would be. The real kicker to all of this is that a bailout is not certain. The German finance ministry has already laid out a six-step process for approving a bailout. First, Greece must officially ask, which it has. Second, the Europeans must examine if Greece really needs the help. Third, Greece must submit a restructuring plan to bring their budget back into balance. Fourth, the potential funders must approve this plan. Fifth, everything must be submitted to the European Council and the European Central Bank for approval. And sixth, this finalized proposal must then be approved by the German parliament. Put simply, all the sound and fury surrounding the Greek economy to this point has been the preamble. Only now are the Europeans – led by the Germans – getting down to brass tacks.

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barrypenders 3 years, 11 months ago

The IMF portion of the bailout — another 15 billion euros — is simpler, as the IMF exists for situations precisely like this and has plenty of money on standby. However, the United States, which has veto power at the IMF, will not consider allowing the IMF portion of the bailout to proceed until the EU portion is committed. Regardless of domestic politics in the United States, Greece is not a banana republic. It is a member of one of the world’s rich-country groupings, and the primary responsibility for assisting it lies with the European Union.

Moreover, while IMF loans may have considerably lower interest rates, they do not come without strings attached. The IMF will require more austerity than the Greeks have put into place. This is not budget reduction at the margins, but cutting to — and through — the bone. The best comparison available is the IMF’s bailout of Latvia in 2009, which required 25-40 percent pay cuts for public employees.

The Obstacles

Greece itself. Greece has a very generous social welfare system, far more generous than Germany’s, so it will resist any more budget cuts. In many ways, this is an extension of the attitude that got Athens into trouble in the first place. Germany. Fresh from making years of budget cuts itself, Berlin does not want to pay for Greece to live the good life. It will push for more austerity like the IMF, for deep EU/German control over the Greek finance ministry, or both. Legal complications. As mentioned before, this is all technically unconstitutional. There will be legal challenges (including, but not limited to, lawsuits) at national and EU levels, and some of this might require parliamentary approval as well. Should a single contributing state for whatever reason not belly up to the bar, the whole thing could unravel. (Why should Vienna pay if Madrid refuses to?) The ad hoc nature of this also presents problems: States will be asked to pay into the Greek kitty in proportion to their economic size based on their ongoing contributions to the EU budget. That will not sit well with states in recession and those that are normally net providers of EU funds but get relatively little back.

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barrypenders 3 years, 11 months ago

From Stratfor:

The Situation

On April 22, Eurostat, the European Union’s statistical arm, issued its first report on the inner workings of the Greek government’s finances. The report identified what everyone has been suspecting for years: Greek government bookkeeping is horrible at best and criminal at worst. The new data indicates not only would Greece have never qualified for eurozone membership in the first place, but Greek governments have continued to lie about the depth of their debt crisis even as they have sought EU financial assistance. The new information — which Eurostat cautions is not complete and will likely get worse — shows the Greek budget deficit for 2009 stood at 13.6 percent of gross domestic product, rather than the previously admitted 12.9 percent.

Bond yields on Greek debt immediately and sharply increased April 21, hitting 11 percent for short-term notes (Germany pays about 2 percent, in comparison). In layman’s terms, investors no longer believe anything that the Greek government says, and any decisions by investors to loan Athens money will require promises of Olympian returns.

Greece can only afford these ever-mounting premiums for a short period, particularly as big tranches of debt roll over and have to be refinanced at these higher rates en masse. As such, STRATFOR views a default as inevitable — perhaps even imminent. Consequently, Greece has called upon the European Union and International Monetary Fund (IMF) to activate their bailout mechanism.

The Process

The bailout will have two portions, one funded by the union and the other by the IMF.

The EU part of the bailout is not ready, despite all the discussions and summits in recent weeks — in fact, the Europeans have not really figured out the terms yet. Despite all the drama of recent months on the issue, the bailout’s status can best be summed up as a theoretical agreement rather than anything concrete. It will take a minimum of another week of talks to hammer out something functional, and that is assuming that everyone agrees on a general plan of action. Remember, there is no EU fund for this — bailouts technically are illegal under the Maastricht Treaty that created the euro — so each EU state will need to bring new money from its own recession-wracked economy to the table for this to work. The working estimate for the EU contribution is 30 billion euros ($40 billion).

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igby 3 years, 11 months ago

The Greek problem is just the tip of the first sign of the failing EURO! The European bond market is on the blink of tumbling! There's chatter, oh yea! It's coming!

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