For Whom The Bailout Tolls

“On an optimistic view, that a deal was struck implies that neither side was ultimately willing to risk a Greek exit because they recognise that no one fully understands all the ramifications of such a decision. Under this scenario, when pressure again builds, the authorities will do the same: let Greece remain in the euro, even if it fails to keep to its adjustment programme. So, the reality of “bail-out II” means that, if the situation becomes critical, there will be a bail-out III”. Sushil Wadhwani, writing in the Financial Times

 So Greece has finally been awarded a second bailout. One may wish the country will live to tell the tale.

According to IMF DG Christine Lagarde, speaking at the post agreement press conference, “It’s not an easy (program), it’s an ambitious one,”. Never a truer word was said, and certainly not in jest. Not only is the program an ambitious one, it is more than probably a “pie in the sky” one too. The objective of 120% for Greek debt in GDP is totally unrealistic, not only because it won’t be attained (it won’t), but because even if it were the country would still be in an unsustainable situation in  2020. So this is hardly something to be proud of, or look forward to.

And then there is growth. Ah yes, growth. Noone really has any idea how this will be achieved, and of course without it even the (un)ambitious 120% goal is way out of reach. But beyond the details, I have serious doubts whether Greece itself is now rescuable. I don’t mean the financial dimension, I mean whether or not the country will even raise its head again. The social fabric and the country’s reputation is being so destroyed, that it is hard to see serious investors getting back into the country again, with or without that much needed internal devaluation.  At the end of the day the Greek bailout is not for the Greeks at all. Certainly they will see very little of the money, and there will be none whatsoever to help restart their withering economy.The Greek bailout is to protect the rest. It is a vain attempt to let Greece go its course (or even die) while preventing the contagious smell from reaching Spain or Italy. The only real creditors now are the official sector. This is not a bailout, it is a “cordon sanitaire”.

The outcome is already almost guaranteed – young people tired of continually being unable to find work commensurate with their skills will simply vote with their feet and leave, leaving an ever more unsustainable pension and health system for the Troika to manage. A common story these days along Europe’s periphery, but still, Greece definitely seems destined to be the worst of worst cases scenario.

Perhaps the best simple summary of what just happened was written by Annika Breidthardt and Jan Strupczewski in their Reuters report:

“The complex deal wrought in overnight negotiations buys time to stabilize the 17-nation currency bloc and strengthen its financial firewalls, but it leaves deep doubts about Greece’s ability to recover and avoid default in the longer term”.

We have just bought some time for the rest of us, while Greece is sent off to default and beyond. The Troika representatives didn’t “sign off” on the new deal, they effectively washed their hands of the whole messy situation. Naturally Greece won’t be able to comply with the conditions, and at the next review, or the one after, the country will be face to face with the inevitable.

The Details

  • Greece has agreed to be placed under permanent surveillance by an increased European presence on the ground, and it will have to deposit funds in an escrow account to service its debt to guarantee repayments. effectively this will rule out future defaults against the private sector. This is why Europe’s leaders think this agreement will end contagion, there will be nothing to “contage”. But the problem simply becomes worse, since any default now will be against the official sector, and they are not nice, friendly people to default on.

  • The European Central Bank agreed to help the process by distributing its profits from bond-buying. A Eurogroup statement said the ECB would pass up profits it made from buying Greek bonds over the past two years to national central banks for their governments to pass on to Athens “to further improve the sustainability of Greece’s public debt.”  The bond holdings of the ECB and national central banks from their investment portfolios (about 12 billion Euros) and the Security Markets Programme (around 40-45 billion Euros) are to be swapped for instruments that appear to be exempt from any future  Collective Action Clauses. They will be repaid at face value, albeit with an understanding that the profits accruing from this repayment plus coupon payments will be transferred to governments via the various  National Central Banks. This money can then be passed to Greece in the form of a transfer. The importance of this arrangement is that it reinforces the subordination of private sector bond holders to central bank buying. Moreover, it is not clear that there is any obligation for the national governments to give these income flows from Greek restructuring back to Greece, and if this proves to be the case this outcome would simply amplify the subordination of private investors.

  • Private bondholders are being asked to accept more losses than originally postulated. Private sector holders of Greek debt will take losses of 53.5 percent on the nominal value of their bonds. They had previously agreed to a 50 percent nominal writedown, which equated to around a 70 percent loss on the net present value of the debt. This being said, all is still far from clear. The IMF document detailing the underlying economic assumptions for Greece assumes a 95% participation rate in the PSI. This outcome seems unlikely, especially in light of the increased haircut for private investors in the new deal, which was implemented in order to reduce Greek debt/GDP to the targeted 120% by 2020 from the 129% it would reach according to earlier PSI assumptions. What this implies is that those dreaded Collective Action Clauses may still be needed sometime early next month to ensure no hold-outs, and if this happens it is quite possible that CDS will trigger. So we are not out of the woods yet, it seems.

  • The latest IMF document reaffirms its view that Greece is unlikely to be able to access the market in its own name during the programme period until at least 2020, “and it is assumed that financing needs are met by Greece’s European partners on standard EFSF borrowing terms”, if good policies are maintained. One problem  the IMF mentions here is important, and that  is the fact that future debt issuance would be subordinated to the currently being restructured pool of debt. This would obviously make it hard to sell bonds to new investors even in the most favourable of circumstances.

  • As if this wasn’t enough in the way of headaches, the latest IMF document also suggests that  Greece is likely to need additional funding well before 2020. The Fund outlines two scenarios: a “base” case whereby Greece may need an additional 50 billion Euros during the period 2015-20 given that the new 136 billion Euro support package will only meet Greece’s funding needs until 2014. They also cite a more bearish case involving slower-than-targeted growth and fiscal consolidation, whereby debt/GDP only declines to 160% by 2020 rather than the targeted 120%, in which case Greece would require a further 109 billion. Hence far from having put Greece off the EU radar, the new debt deal only marks the end of the beginning, and we still need to get through to the beginning of the end.  

  • In terms of timescale, the private creditor bond exchange is expected to be launched on March 8 and complete three days later, according to Greek sources. That means a 14.5-billion-euro bond repayment due on March 20 would be restructured, allowing Greece to avoid default.

    In fact the important point to note is that the vast majority of the funds in the current program will be used to finance the bond swap and ensure Greece’s banking system remains stable; some 30 billion euros will go to “sweeteners” to get the private sector to sign up to the swap, and 23 billion will go to recapitalize Greek banks. A further 35 billion or so will allow Greece to finance the buying back of the bonds. As Annika Breidthardt and Jan Strupczewski point out in their article, next to nothing will go directly to help the Greek economy.

    The main purpose of exercise – apart from trying to close off contagion – was to reduce Greece’s debt to a level that the IMF would be able to continue funding. It will be recalled that the whole second bailout issue was put on the table when the IMF reported that it would be unable to continue with the first bailout since its own regulations stipulated it could not continue to make programme payments to a country whose debt path was not sustainable. Their economists must have had to swallow some to be willing to sign off on the sustainability of this one. But such are the political pressures people are facing.

    The Sacrificial Lamb

    It is hard to remember a time when such an important decision was taken with so many of those involved expressing the view the solution was not going to work. Thus conservative leader Antonis Samaras, a strong contender to become next prime minister, stressed that the rescue package’s debt-reduction targets could only be met with economic growth. “Without the rebound and growth of the economy … not even the immediate fiscal targets can be met, nor can the debt become sustainable in the long-term.”

    Hardly inspiring words from the person who is most likely to have to take responsibility for all of this, especially since he appreciates perfectly well that all that growth simply isn’t coming. At some point the economy will strop contracting, be we will certainly not see a significant rebound, but rather a dead cat bounce.

    Europe’s leaders, on the other hand, are more concerned about their own backyard than they are about what actually happens to the Greeks. “It’s an important result that removes immediate risks of contagion,” Italian Prime Minister Mario Monti is reported as telling a news conference.

    Swedish Finance Minister Anders Borg effectively summed the cynicism of the whole position up like this: “What’s been done is a meaningful step forward. Of course, the Greeks remain stuck in their tragedy; this is a new act in a long drama. “I don’t think we should consider that they are cleared of any problems, but I do think we’ve reduced the Greek problem to just a Greek problem. It is no longer a threat to the recovery in all of Europe, and it is another step forward.”

    But as Sushil Wadhwani suggests, rather than overcoming contagion, what the agreement does is give a whole new twist to the issue. In particular, the general impression that has been generated is that Germany’s leadership will now make almost any concession in order not to have to look for the Euro exit door, and the others, starting with the highly intelligent Mario Monti, are beginning to sense this. Even Spain’s Mariano Rajoy has caught-on, and seen he can negotiate a relaxed deficit target for 2011, despite the fact that the country missed last year’s target by a large margin. So we may well now see a chain of events were one country after another sets out to test the patience of the “core”. And in addition (see below), even the Greek contagion problem is a long way from being over.

    Eternal Life on LTRO “Cool Aid”?

    Meawhile, the impact of recent policy changes at the central bank should not be underestimated, in terms of the durability of this tragedy in multiple acts . In particular, the latest decision to implement two 3 year Long Term Repo Operations has been very important. Indeed it is a short term game changer.

    Distressed sovereigns can, for the time being fund themselves, even if the commercial banks are only really inclined to bid at the short end, and may well be exaggerating the extent of spread relief provided by buying short term bonds in an attempt to store liquidity to meet their own future wholesale financing needs.

    Basically, the liquidity provided, in conjunction with the all important flexibilisation of the collateral rules, has enabled banks to make provision for their wholesale funding needs right through from now to 2015, at which time there will doubtless be another round of LTROs, and who knows, they could even have a longer term than a mere three years  now that the distinction between capital and liquidity has become totally blurred. The days when banks saw it as a stigma to have recourse to ECB liquidity, and when journalists entertained themselves making fun of packaged used car loans being offered as collateral in Ireland by the Australian bank Macquarie are now long gone, as are the times when anyone really imagined that any sovereign bond from a country losing the minimum rating qualification of at least a single A from one agency would not be available for use as collateral at the central bank.

    What the LTROs won’t do is stimulate credit in countries where there is little solvent demand for borrowing. Countries like Greece, for example. Crashing the economy without restoring competitiveness means that Athena does not rise from the head of Zeus out of the ashes of created destruction.

    But this liquidity policy does knock yet another of the “old chestnut” endgames straight out of the window, since it makes deposit flight within the Euro Area as a whole a much smaller problem. German and other core country deposits can be recycled – via wholesale finance provided at the ECB – as a substitute for the missing peripheral ones. As I say, this measure does not unblock the credit crunch problem, but it does reduce immediate systemic pressure. So, if the Euro system is inherently unstable, and unsustainable, a mire from which no one wants to exit since fear of the unknown always trumps hatred of the known, how does it all finally unwind?

    The implicit market assumption the markets are making that Portugal will follow Greece into default comes as no surprise. If Greece is to be given an ongoing debt pardoning programme then surely in Portugal is going to want one too. And then there will be Ireland, and so on. Yet all of this is contemplatable, what is not contemplateable is that the people who live in these unfortunate countries will continue to accept whatever is thrown at them, and then some, come what may. You only need to look over in the direction of Hungary to see that these no-growth austerity programmes have a sell-by date. But what will follow will surely please no one.

    The Club No One In Their Right Mind Would Leave

    But what about Greece itself? Logic suggests that they will be unable to meet the terms of their new agreement, and that we will soon be back to where we started, …….or will we?

    Feelings that what we are seeing today will only constitute a short interlude in a pretty atonal concierto are based on an appreciation of three important factors: a) a recognition that even a reduction of debt to GDP to 120% by 2020 is still not sustainable; b) a recognition that after the formal bailout is awarded there will still be ongoing programme reviews, and the country will struggle to comply with the conditions; and c) the fact that the implementation of the Private Sector Involvement debt swap will probably mean changing the jurisdiction under which Greek debt is denominated from mainly Greek law in the majority to international law in the totality, and that the only creditors left on whom the country can effectively default is now the official sector. This latter point is undoubtedly the most important, although being able to grasp its full implications implies an understanding of the first two.

    Essentially, if the unsustainability of the Greek debt path and the inability to comply with conditionality are accepted, then a further default will be inevitable, but such a default will undoubtedly be a very, very hard one, and most likely an uncontrolled one. In the first place if the country were to leave the Euro after the debt swap, then the new Greek bonds could now not be converted to New Drachma (or equivalent) by a weekend session of the Greek parliament, and the country would have to default on bonds denominated in Euros, which would presented them with all kinds of problems.

    Secondly, given the terms of the debt swap, and the condition of an escrow fund to protect the interests of private bondholders, then the only liabilities on which the country could still default would be those commitments it has with the official sector, which means defaulting on the IMF, the ECB, the EU and Germany. These would not be especially nice people for the country to default on, since if Greek reaches such a point the country would almost surely be made an example of, which means effectively establishing a pariah state.

    The EU certainly wouldn’t be sending in the social workers and psychologists to help them cope with this massive tragedy, which would evidently create such social and political chaos that investors generally would be inclined to steer clear. Realising this, and having taken the decision not to default now, faced with the alternative of seeking allies among other rogue states (the North Korea path) the country’s leaders have probably taken the decision to stay in as long as they can. But then it is worth remembering the old Greek saying that “whom the gods would destroy, they first make mad”, by which I mean we could well eventually see extreme factors at play in Greek politics – the extreme right, the extreme left, and the military – before they then all go rolling off the cliff together.

    Or maybe Greece will decide to default and stay in the Euro, printing its own Euros at the national central bank along the lines of the Emergency Liquidity Assistance precedent. That would surely create a mighty mess, (they could even carry out the internal devaluation by subsidising Greek wages) and would leave the onus of kicking them out on their European partners.

    Whichever the appointed path, such a scenario would have important geopolitical implications, since surely the EU could not let Greece become a nice place, given that then Portugal would immediately say “I want one of those”, and so on and so forth along the daisy chain. In the meantime private capital will be steadily forced out of periphery sovereigns like Spain and Italy, and the ECB will ultimately have to provide. But we have already crossed the Rubicon on this, and there is no real turning back. Ongoing debt restructuring will continue, as none of the really troubled economies can either grow or sustain their existing debt. I mean, who can now really believe that Spain won’t be asked in six months time to prepare another set of reforms (the latest batch have “destined to fail” written all over them), and six months later another one, and so on, until eventually the country is where Greece is now?

    And if the private sector either can’t, or won’t accept the degree of involvement being asked of it, then the ECB will be taken out of the official sector, and somehow or other find a way to swallow the losses. At least that’s the way things could work for the time being.

    Destroying European Democracy?

    The principal issue impeding exit is not the one of the presence of sunk costs from years of membership, but rather existence of non-linear credit and currency impacts – in either one or the other direction – impacts which could not be envisaged in the pre-Euro era during which most of the critics of the common currency cut their theoretical teeth.

    The only conceivable way a deliberate decision to leave could actually be taken would be as a result of one or more of the respective agents being actually driven “insane” by the constant painful efforts involved in trying to retain the pin in that grenade they are holding as they are driven to ever more desperate efforts in a vain attempt to try to stop it going off in their face. Could, for example, Hungary’s leader Viktor Orban be about to offer us an early prototype for the kind of road map which some of the participants might need to follow in order to reach the point whereby they actively decide to leave? In Hungary’s case, of course, the departure would be from the EU, not the Euro, but the point is effectively the same, since the farewell party would most certainly acrimonious, where the possibility of regulating the exit would be limited, and where the end product would almost certainly be the creation of a pariah state.

    For the inevitably defaulting participants, given the total determination not to have official sector restructuring, leaving the Euro would more or less automatically mean a sharp break with both the EU and the IMF and in all probability the United States. If we take Greece as an example, and assuming the currently proposed PSI debt swap goes forward, the country will almost certainly see the jurisdiction of its debt shifted from national to international law, making converting sovereign debt instruments into New Drachma (or whatever) impossible, and given the creation of an escrow account to pay the private sector creditors, the only meaningful possibilities for default would be against the official sector – the ECB, the IMF and the EU member states – and clearly such a development would not be well received, among other reasons due to the precedents which could be created for other struggling countries who might wish to follow the same path.

    So the list of probable allies for an exiting country – Venezuela, Bolivia, and North Korea come to mind, or nearer home Serbia, Belarus and Ukraine – would not be entirely alluring. The difficulty is that after the ending of the cold war, the world is rather short of role models for developed economies who want to pursue unorthodox policies, especially if they are engaged in a disorderly default causing considerable discomfort for most of their “first world” peers at the time in question.

    On the other hand, those with more stable, internationally competitive economies will not readily wish to surrender this condition, and since they have clearly benefited significantly from membership of the currency union they will be unlikely to offer themselves as candidates for departure. In a post Euro world they would face the likelihood of trying to export their way forward while labouring under the constraint of a substantially over-valued currency. They need only look over in the direction of Japan to discern the outline of the future that would await them.

    So with no one leaving, and each elbowing the other in the rush to say “I’m not going”, there really only is one way all this can end, isn’t there?

    This entry was posted in A Fistful Of Euros, Economics, Economics and demography, Economics: Country briefings, Energy and enviroment by Edward Hugh. Bookmark the permalink.

    About Edward Hugh

    Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

    32 thoughts on “For Whom The Bailout Tolls

    1. I think you vastly underestimate the willingness of the ‘official sector’ to cancel debts in the future. Of course they will always always do it at the last minute and in small increments, because it’d be silly to give up earlier than necessary and lose bargaining power (with Greece and the other guys) and the option to get paid back should growth unexpectedly come back. Basically it’s both politically impractical to pardon the debt now and not to pardon it later.

      If you generalise the escrow account setup, this can be done without Greek involvement at all: one arm of the EU just adds some funds to the escrow account that are used to pay what other arms of the EU are due as and when it runs low.

      Also on the willingness of the “private” sector to participate in the PSI, we’ll know soon, but all the major eurozone banks don’t have a choice really: they can get nationalised/shutdown quickly if they don’t comply, they know the bargain and have therefore already agreed. The participation rate is really a question of how much is really owned by truly private operators.

    2. Well, I will wait and see on the IMF. Remember Spain and Italy are coming for their “pardoning” as night follows day, and with little in the way of growth prospects. If the IMF go for systematic pardoning, then this will be effectively a transfer of resources from poor emerging market countries like Brazil and India to rather richer mature ones. I’ll believe all this when I see it. My feeling is that Greece will be made an example of to discourage the others, but then they too are already in impossible situations. One day or another something has to give.

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    4. The idea that Greece would be a complete pariah is perhaps overstated.

      An argument could be made that the IMF were at fault for not insisting on a devaluation as a condition for their funding. The IMF allowed itself to be dragooned into a rescue of a currency area rather than of Greece.

      The US UK and others not absolutely committed to the survival of the eurozone may be prepared to offer help (and diplomatic cover) to a ruined Greece seeking to recover.

    5. Thanks to EH for the best discussion I’ve seen on the bailout. There seems to be “bailout fatigue” in the global financial press as if to say “the deal is done, see you in a few months when we start over again.”

      If I may use Greek imagery, the Achilles’ heel is the concept of “growth.” growth in Greece from where? Industry? Ridiculous. Technology? Impossible. Commodities? Don’t be silly. If Europe as a whole enters into a growth cycle, there might be some spillover, but that’s not going to happen soon, is it? The idea, by TM, that banks will have to invest in an economy that will decline is nonsensical. The only solution, which the pols are avoiding, is to move Greece out of the Euro into a devalued Drachma.

      I fear for Italy and Spain, and ultimately, the European idea.

    6. Great article, Edward. How do you feel about living in Spain, when the Frankenstein currency, or its successor, may collapse beneath your feet ?

    7. Thanks for the comments everyone.


      “The idea that Greece would be a complete pariah is perhaps overstated”.

      Well look, I am being very careful here. I am postulating Greece exiting against the wishes of the Troika. Now you mention countries like the UK and the US, but up to now, from what we have seen, these countries realise that they have lots to lose from a disorderly break-up of the Euro. Naturally, if all parties were to agree on Greek exit, then the UK and US position would be different, but I really seriously doubt they would risk a outright confrontation with the EU which might cause a global economic implosion.

      Also, I am arguing very clearly that Greece would never vote to leave in a rational manner. Look what happened in Argentina. What you would face are several years of chaos as “regular” politicians are replaced by “irregulars” and the far right fight it out with the far left.

      On top of this, if Greece were allowed to return to the Drachma with kids glove conditions, don’t you think Portugal, Ireland, Spain and Italy would want the same treatment? This isn’t only a Greek question.

      Then you would be left with an over-valued rump, which like Japan would be struggling to export. The Germans would never accept that without a fight.

      So I don’t see any “sane” answer here, and like I say at one point, what is at risk is the whole future of European democracy. Look at Hungary, which is the country which has been living with austerity the longers (6 years). They can’t devalue in any serious way due to all the CHF loans. Things are more complicated now than they were in the 1990s.

      Miles, the only orderly solution is to devide the thing in two, or disband completely, but we aren’t going to see either of these, which is why I fear a steady and ongoing deterioration. The police chief in Valencia who ordered the police charge against schoolchildren protesting about having to study in buildings where there was no money for heating called them “the enemy”, raising memories of earlier experiences here.

      “How do you feel about living in Spain, when the Frankenstein currency, or its successor, may collapse beneath your feet ?”

      Sally, it feels great. It is a lovely country, and the people are great. But then I’m not an investor or looking for business. Then things would be different. It will be impossible to sell off all that coastal property while people still have doubts about which currency the country will be using ten years from now.

    8. I have to say that the GDP forecasts at the base of all this are quite fantastic, and that the whole project is inconsistent in terms of basic national income accounting. On the one hand, we’re asked to believe there is going to be a succession of massive real wage cuts, which can only conceivably mean massive cuts in aggregate demand. On the other hand, we’re asked to believe in several years of strong economic growth. Further, the nominal debt/nominal GDP ratio is meant to be coming down in a context of wage deflation and therefore, price deflation.

      The only way this could happen would be if the rest of Europe was to commit to an absolutely massive program of demand expansion, so as to increase Greek exports dramatically and also to inflate off some of the debt. Do you see any sign of that? And if that’s an option, why are we in this bunker and whose are those planes overhead, as Molotov said to Ribbentrop?

    9. The EU can reimburse the IMF should their taking a loss be deemed unacceptable, I don’t think their involvement, while regrettable, changes the dynamics of the problem materially.

    10. “The EU can reimburse the IMF should their taking a loss be deemed unacceptable”

      Yup, but the thing is cig, the IMF is partly there in the first place because most of the EU participants don’t want to be seen to be taking losses in the first place, so the idea of taking even more would be even more unpalatable. Well, but you are right, outside of Eastern Europe the IMF are in for the smaller part of the cake, and I guess they are there to use to threaten up the participants. It is a pity, becuase I think I was one of the first people (on this blog in fact) to argue for IMF involvement in Greece, since I thought they would be a countrebalance to the EU, but now the EU has simply “assimilated” (for the time being) the IMF. Now the whole world (including places like China) have been drawn in in a way which means the eventual unwinding will not be pleasant to watch. I read somewhere last week that the Chinese were also demanding official status for their bond holdings.

      But the thing is this, if the IMF do finally walk away from the EU, and wash their hands of the situation, Europe’s credibility will really go through the floor. On the other hand, if they stay in, an extraordinarily hard default woudl seem to me to be unavoidable. I really don’t know if the IMF will ever be able to be the same again.

      Some would say that was a good thing, but I wouldn’t share that view. Luckily the developing economies by and large don’t need too much help right now.

    11. “The only way this could happen would be if the rest of Europe was to commit to an absolutely massive program of demand expansion, so as to increase Greek exports dramatically and also to inflate off some of the debt. Do you see any sign of that?”

      Absolutely not. I agree entirely with your sentiments Alex. As krugman once said, we all need to export, but to which planet are we all going to do the exporting?

      The numbers don’t add up, and in addition we are talking about export driven expansions in a developed world which isn’t that far away from being in a long term slump once you add in all the participants (US, UK, Japan, etc…).

    12. Incidentally Tony,

      “An argument could be made that the IMF were at fault for not insisting on a devaluation as a condition for their funding. The IMF allowed itself to be dragooned into a rescue of a currency area rather than of Greece”.

      I think this battle was lost in the Baltics. In Latvia specifically. Once the IMF caved in to the EU on not letting Latvia default they were already on the slippery slope, and have been being steadily converted into an appendage of the EU ever since. The IMF now uses no macroeconomic langauge, and it is all micro structural reforms, as originally preached by the ECB.

    13. The eurozone and probably the whole EU cannot be saved under the current form. Greece is only the tip of the iceberg of problems.

      The (already implementing) plan is the european unification and the introduction of eurobonds. Otherwise not only Greece but almost all european countries will not be able to finance their mounting debts with an affordable cost.

      Just take a look at the amounts needed in the upcoming months let alone years and you will understand. The ECB simply cannot announce trillions of LTRO every few quarters simply to give cash to the banks to finance those debts.

      So Greece is taking the best option it has, stay in at all costs until the zone unifies its economies and finances the european debt under a common platform.

    14. I’m the dumb one.
      How’s it going to end? Kind of a cliffhanger there in the last sentence: are you thinking full fiscal and political union or total breakup, or just Greece leaving all by itself?

    15. Excellent post, and excellent comments too btw.
      I think you may be too hard on Spain and Italy. I assume that the strategy is to kick the Greek can down the road as long as it takes to get at least some growth in Spain and Italy, maybe even in Ireland.
      We are seeing some minor hopeful growth signs across the Atlantic, and surely between this and 2020 the Northern Europeans will have achieved at least some modest growth and wage inflation.
      Don’t you think the ‘primary surplus’-countries will have gotten out of the woods by say 2017?

    16. Pantom:

      “How’s it going to end?”

      This is the interesting thing about history, it isn’t written in advance. Nick could be right that there will be full fiscal union complete with a Treuhand-type Marshall plan for economically rebuilding the South under a very short time horizon – ie quick enough to save the thing before it busts. But that doesn’t look likely at the present time.

      I think I make the other option clear enough – “whom the gods would destroy they first make mad” – which is another way of saying we will see a continuing deterioration in European democracy levels and standards as populations go for ever more “loopy” solutions due to the frustration produced by the fact the official versions don’t work. People say I am unfair on the IMF in saying they have some responsibility for what is happening in Ukraine, and possibly so. But who remembers the “orange revolution” (which once made this blog famous worldwide) now? Hungary is coming next. It is perfectly possible the country will eventually be suspended from the EU. And it likely won’t be the last. And Greece itself. What sort of government will we really see after the next elections, a technocratic, or a populist one? And if the latter, where do we go from there.

      The important point to grasp is the one Nick makes, this isn’t just about Greece, in my opinion it is about how to manage lowering expectations in a set of rapidly ageing societies. Structural reforms may help a bit here and there, but they won’t change the underlying problem.

    17. Hi Belgo,

      “I think you may be too hard on Spain and Italy”.

      Well some may say so, but I don’t take that view. Evidently I can’t explain all my argumentation here, and you will need to leaf through the earlier posts (I have country specific blogs in each case – Spain Economy Watch and Italy Economy Watch. The situations are quite different in each case. Italy has a long running growth problem, with trend growth dropping steadily by about 1% a decade over the last 4 decades. In the ten years to 2012 it is quite possible the country’s economy will have shrunk on average every year depending on the final result we get this year. In 2013 GDP could be back at levels last seen at the end of the 1990s, and growth in the decade 2010 to 2020 is likely to be negative on average.

      There are lots of reasons for this (growth in the underground economy would certainly be one) but the fact is unmistakeable that Italy has rapidly rising contingent liabilities to a rapidly ageing population and an internationally insufficiently competitive economy even to give them a goods trade surplus. They can’t carry 120% debt to GDP forward under these circumstances. Bad thinking people might even imagine that the magic number of 120% was dreamt up for Greece (it would be hard to find backing in any literature for this number) since anything lower would throw the spotlight on the fact that Italian debt was unsustainable.

      And if Italy is to face a decade of wage and price deflation to restore competitiveness then Alex’s point kicks-in, they will have Japan style declining NOMINAL GDP which will make the accumulated debt problem even worse.

      My view is that Italian debt is on a knife edge, and that those who think it will “edge down” are being over optimistic. It will edge up, and this will become abundantly clear over a horizon of approximately 18 to 24 months, which is the time horizon the EUs leaders have to get their act together for the “last waltz”.

    18. On Spain, where I live, the problem is quite different – the economy is literally imploding following the collapse of an enormous housing bubble, during the years of which a significant part of the country’s industrial base was wound down. The issue in Spain isn’t really about deficits, it is about private debt and solvency in the financial sector. The government has a deficit since the revenue needed to support the current levels of welfare spending simply isn’t being produced by the economy.

      This has no easy answer, and I think there is even relatively little the government can do except grin and bear it, and wait to see what happens next on a European level. A 20% internal devaluation would, of course, work wonders, but no one is going to buy this for the reasons Alex explains.

    19. Incidentally cig, on the IMF, I was reading this Bloomberg piece, and their Greek exposure certainly is becoming a touchy issue:


      The International Monetary Fund will seek to keep its exposure to Greece under a new bailout package at 30 billion euros ($39.8 billion), including money still owed from a previous loan, an IMF official said.

      IMF Managing Director Christine Lagarde has indicated that the fund’s credit to Greece after the second loan will remain at the maximum available under a 30 billion-euro loan agreed in 2010, said the official, who spoke to reporters in Washington yesterday on condition of anonymity. About 10 billion euros of the first loan hasn’t been disbursed, the official said.

      The IMF has yet to announce its share of the 130 billion- euro bailout package. With about $108 billion already promised to euro countries, including Portugal and Ireland, Lagarde must heed members’ calls to limit its commitments to the currency bloc, said Thomas Costerg, a European economist with Standard Chartered Bank in London.

      “One of the main uncertainties of this Greek deal is the IMF participation,” Costerg said. “There’s some pressure from emerging markets and the U.S. to limit the IMF exposure to Europe, and it’s also a way to put pressure on Europeans so that they beef up their own existing rescue mechanism.”

      Group of 20 nations should discuss possible further resources for the IMF after Europe decides on its financial firewall, the U.S. Treasury Department’s top international official said.

      Lael Brainard, the U.S. Treasury’s undersecretary for international affairs, said yesterday that a “large share” of the funding to solve the euro-area crisis will come from the region itself.

      “The IMF should continue to play a constructive role in Europe but IMF resources cannot substitute for a strong and credible European firewall in response,” Brainard told a news briefing in Washington. “I’m sure when Europe’s response becomes clear the G-20 will be able to better assess IMF resources.”

    20. Abandoning Euro and passing to a new Dracma won’t work, for the simple reason that you’ll have to pay a debt in euro with a devaluated piece of paper. It’s really sad to say, but Greece is gone.
      ECB must buy time for Spain and Italy hoping they can restore a decent growth. It’s what LTRO does. Is it enough? I’m afraid that the answer is negative, especially for Spain.

    21. Having lived through the debacles in Argentina and Brazil, with Argentina tying itself to the dollar, and with devaluation the only resort and reading all the well-reasoned and pessimistic remarks in this blog, the question in my mind is not if (leaving the Euro and devaluation) but when? The longer it goes on, the longer Spain and Italy are at risk, and if they are at risk, so then is the rest of the Euro-zone, minus Germany. We are also underestimating the looming anti-German nationalism that will only grow worse as the time bomb keeps getting kicked down the road (sorry about the mixed metaphors). Finally, I wonder when the Chinese are going to grow tired of supporting the Euro and that currency drops, as it must if competitiveness is to be restored in Southern Europe.

    22. “who can now really believe that Spain won’t be asked in six months time to prepare another set of reforms (the latest batch have “destined to fail” written all over them), and six months later another one, and so on, until eventually the country is where Greece is now?”

      Not just not-so-good, but bad as that? “where Greece is now”? Even Ireland is a long long way from “where Greece is now” and it’s not impossible that things might get a little better there. If you really believe that, it’s sayonara for the Euro.

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    24. Otto,

      “”Not just not-so-good, but bad as that? “where Greece is now”?”

      OK, you are right, I need to qualify this statement. I don’t mean where Greece is now as far as the debt dynamic goes, I mean where Greece is now as far as the kind of reforms and sacrifices which will be asked of the population is concerned, and the kidn of social tensions which will have built up. I couldn’t say when Spanish sovereign will hit a “no-return-spiral dynamic” and need a second bailout with debt pardoning (assuming we can call a combination of the 3yr LTROs and the ECB SMP the first one) – although if the experiment continues I am sure we will get there at some point. Spain isn’t through the 100% debt to GDP mark yet, although two years from now it might be near breaking water on that milestone if all the off balance sheet debt is consolidated and the deficit keeps ticking along.

      The thing is, there is no end in sight, so in Spain things will continue to get worse, and then continue to get worse. Or can anyone point me to an indicator which is improving 5 years after the country started to enter recession?

      Italy will clearly need a second bailout before Spain does.

    25. Miles,

      “The longer it goes on, the longer Spain and Italy are at risk, and if they are at risk, so then is the rest of the Euro-zone, minus Germany”.

      Why do you assume Germany is not at risk? If the Euro breaks up I would say the German economy was one of the most exposed (no one will be doing well) – first they will have to handle all those defaulted debts in their banking system, and then they will have to try to compete in exports with a highly overvalued (safe haven) currency. Regarding the latter, take a look over towards Japan.

    26. Spike,

      “Abandoning Euro and passing to a new Dracma won’t work, for the simple reason that you’ll have to pay a debt in euro with a devaluated piece of paper. It’s really sad to say, but Greece is gone”.

      Unfortunately I have to agree with you. The only way a transition to a New Drachma could be done having let things get as far as they have come would be if those holding the debt (basically the Troika) were to facilitate this happening by allowing a smooth default. What I am arguing is that they won’t, and the outcome will be the one you mention.

    27. Thanks for your analysis, Edward. I’m afraid no further comment is required.

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    29. Several more comments are required.Q:Who is in control here?A:The Western based international high finance clique,not the EU politicians or bureaucrats-they are mere stooges.Q:What is the covert agenda of this clique in control?A:To enforce the printing of Euros in order to cream off and squeeze out every Euro until the EU and the economies of the EU countries collapses.Q:Why would they want to do that?A:1-To buy the assets of Europe wholesale,on the cheap.2-To destroy democracy proper,and replace it with the USA Claytons version.3-To pay back Europe for having killed so many Jews during WW 11.This is only my opinion,but the only other logical conclusion possible is that the people running the EU and their supporters are quite insane.They are knowingly destroying democracy,respect for law and order,the economies in Europe,and they are printing money backed by nothing but the future sales of assets to pay off the debts.People have lost their marbles and have no idea anymore what the word economy stands for.Too many went to university,into office jobs and the public service(sic).

    30. Things could get very ‘interesting’ if the Greek government collapses and there are new elections. Last I read, the two main parties between them have the support of only 1/3 of the electorate. The result could be a parliament with a whole mess of leftist and populist-nationalist parties that makes the Belgian coalition formation look like child’s play. Meanwhile a ‘caretaker’ government would continue to carry out the orders of the troika with no real democratic mandate.

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