16/3/2012: Greek Bailout 2 - Globe & Mail

A quick link to my article on Greek bailout-2 for Economy Lab with Globe & Mail (here) and related subsequent article on ZeroHedge on the same topic (here).


Below is the full version (unedited) of the Globe & Mail article - double the length of the print version.

With the Greek Bailout 2 on its way, has euro zone escaped the clutches of the proverbial markets? Not a chance. Greece remains the eurozone’s ‘weakest link’ and Europe remains the Sick Man of the global growth. The reasons are simple: debt, liquidity and growth. Let’s first focus on Greece, debt and liquidity, with a subsequent post dealing with Euro area growth.

Part 1:

Debt-wise, Greece is now actually worse off than when the whole mess of the second bailout began. After the PSI that, together with the ECB swap, amounts to a $138bn debt writedown, Greece is now in line for $170bn in new loans, an additional $38bn EFF ‘pro-growth’ lending facility from the IMF, and a standing $40bn reserve loans facility for its banks. As of today, the expected Greek banks bailout bill stands at $63bn. Behind all that looms another $20bn yet-to-be-announced lending package that will be required to get Greece over 2012 targets, given the deterioration in its GDP. All in, Greek debt can rise by as much as $130bn with Bailout-2, although the most likely number will be around $100bn. This would bring Greek gross external debt from 192% of GDP projected pre-Bailout 2, to over 225%, using IMF figures.

Keep in mind that Greece cannot print out of this debt, nor can it expect to grow out of it. The Greek economy is expected to shrink -3.2% this year and post just 0.6% nominal growth in 2013. Thereafter, rosy projections from the IMF are for 3.3% average annual growth out to 2016. All of this growth is expected to come from gross fixed capital formation and exports. The former will be happening, according to the IMF numbers, amidst shrinking public and private demand and zero per cent private sector credit creation through 2014. The latter is expected to add 39% to the country exports of goods and services over the next 4 years. German tourists better start coming into Greece in millions, because feta cheese sales doubling between now and 2016 will not do the trick. In other words, the rates of growth envisioned by the IMF are purely imaginary.

On the liquidity front, European periphery remains largely outside the funding markets. Even Italy is now borrowing in the markets courtesy of ECB pumping cash into the country banks. Of the top ten LTRO borrowers by overall volume, seven are from Spain and Italy. Fifteen out of top twenty banks, measured as a ratio of LTROs borrowings to their assets, are from these countries. Since the beginning of 2009, ECB has unloaded some $1.65 trillion of new funds. Much of this went into the sovereign bonds and ECB deposits.

Now, here’s the obvious problem at the end of the proverbial Cunning Plan that ECB contrived to shore up ailing banks. Euro area banks are the largest holders of Euro area sovereign bonds. This reality was the main channel for contagion from the sovereign balancesheets to the banking system of the current crisis. LTROs 1 and 2 have just made that channel about a mile wider. Mopping up the expected tsunami of bonds that will hit private markets in and around LTRO winding up dates in 2014-2015 will be a problem of its own right. Coupled with the bonds redemption cliff faced by some peripheral countries around that time will assure that the problem will be insurmountable.

Part 2:

With the Greek Bailout 2 euro zone did not escape the clutches of the proverbial markets. The reasons are simple: debt, liquidity and growth. While the previous post focused on Greece, debt and liquidity, the current post deals with the core source of the weakness in the region’s growth dynamics.

With Greek Bailout 2, Europe has run out of options for supporting its failing states and in doing so, it has run out of room for its economies to grow. Domestic savings are stagnant and, given already hefty fiscal spending bills and rising tax burdens, availability of private capital will be a major problem for investment in the medium term.

Take a look at some numbers – again courtesy of the unseasonally optimistic IMF. Between 2011 and 2014, IMF predicts PIIGs economies to grow, cumulatively by between 1.7% for Greece, Italy and Portugal, 4.8% for Spain and 5.7% for Ireland. However, in recent months IMF has been scaling back its forecasts so rapidly and so dramatically, that the above figures can become, by April 2012 WEO database revision, -0.1% for Greece, 5.0% for Ireland, 1.6% Italy, 1.5 Portugal and 3.3% Spain. Not a single Euro area member state, save for Greece is expected to see more than 2 percentage point increase in gross national savings. Coupled with fiscal consolidations planned, this implies negative growth in private savings as a share of GDP in every Euro zone country. Over the same period, General Government revenues as a share of overall economy will increase on average across the old Euro area member states (pre-2004 EU12). The much-hoped-for salvation from external trade surpluses is an unlikely source for growth: between 2011 and 2014, cumulative current account balances are likely to be deeply negative in France (-7.4% of GDP), Greece (-16.9%), Italy (-7.5%), Portugal (-15.5%), Spain (-8.2%) and only mildly positive in Ireland (+4.9%). Average cumulative 2012-2014 current account deficit for PIIGS is forecast to be in the region of -8.7% of GDP and for the Big 4 states -1.6%.

This lacklustre performance comes on top of the on-going and accelerating banks deleveraging that will further choke of credit supply to the real economy. Hence, broad money supply across ECB controlled common currency area is declining and ex-ECB deposits, banks balance sheets have shrunk some $660bn in Q4 2011 alone, roughly offsetting the effect of the LTRO 2. You can bet your house the real retail cost of investment is going to continue rising through 2012 and into 2013, exerting a massive drag on growth. Thereafter, unwinding of LTROs will lead to a spike in the benchmark ‘risk-free’ sovereign rates, once again supporting inflation in the cost of business investment.

With all of this, PIIGS are going to be squeezed on all sides – fiscal, monetary / credit, and the real economy – both in the short run and in the medium term. Spain is the case in point with the latest spat with the EU on widening deficits. This week’s news that the EU decided to back down on its own targets for Spanish deficits does not bode well for the block’s credibility when it comes to fiscal discipline. But it signals even worse news for anyone still holding their breath for Europe to show signs of an economic recovery.

If anything, the last two weeks of the Euro crisis are reinforcing the very predictions I made some months ago – Europe’s governments are incapable of sticking to the austerity targets they set for themselves, and are unable to spur any growth momentum to substitute for austerity. In other words, Europe is now firmly stuck between half-hearted dreaming for Keynesianism by default and fully-pledged monetarism by design. As the ‘Third Way’ – this combination of policies is the fastest path to economic hell.