Economics 29/04/2010: Debt crisis is spreading

Another credit downgrade from S&P, this time for Spain, from AA+ to AA with negative outlook, based on the outlook for years of private sector deleveraging and low growth. Spain, as you can see, is severely in red in terms of debt, ranking 14th in the world. Spain's external liabilities stand at 186.1% or $2.55 trillion (as of 2009 Q3) against estimated 2009 GDP of $1.37 trillion.

The country is actually worse off in terms of debt than Greece which has ranks 16th at debt at 170.5% of GDP or $581.68 billion, with 2009 GDP of $341 billion.

Of course, Ireland is world's number 1 debtor nation with external debt of 1,312% of GDP (IFSC-inclusive) of $2.32 trillion in Q3 2009 against the GDP of $176.9 billion. Of course, part of this debt is IFSC, but then, again, we really do not have a claim on our GDP either, with GNP being a more real measure of our income. So on the net, our debts - the actual Irish economy's debts - are somewhere in the neighborhood of 740%. This is still leagues above the UK - the second most indebted nation in the world - which has the debt to GDP ratio of 'only' 426%!

The S&P also provided estimate for expected recovery rate on Greek bonds, which the agency put at 30-50%. In other words, S&P expects investors in Greek bonds to be paid no more than 30-50 cents on the euro. Yesterday on twitter I suggested that "Greek debt should be renegotiated @ 50cents on the euro - severe default. Portugal's @ 80 cents - mild default, Irish @ 70-75 cents". Looks like someone (S&P) agrees. Before it is too late, before German and other European taxpayers have poured hundreds of billions of euro into the PIIGS black hole of delinquent public finances, Europe should cut losses and force Greece and Portugal to renegotiate their liabilities. If Ireland and Spain were to elect to follow, so be it. Of course, in Irish case, the debt re-negotiations should cover private debts, not public debt.

Just how many billions of euros are EU taxpayers in for for the folly of admitting Greece - a country that spent 90 years of the last 180 (since 1829) in defaults on its debts - into the common currency area? Well, Greek 2-year bonds were traded at yields of 26% yesterday at one point in time. This is pricing that's in excess of pretty much every developing country, save for basket cases which practically cannot issue bonds at all.

IMF's Dominique Strauss Kahn has told Bundestag yesterday that Greek package will be

• €100-120bn for three years;
• Which means German taxpayers are on the hook for €67 billion over 3 years, not €25 billion that Germany ‘s economics minister was signing for in the original deal;
• Ireland's contribution will also have to rise to €4 billion over 3 years, not €500 million we originally were told we will have to contribute;
• Greece will not be forced to restructure or reschedule debt
• The loans to Greece will be subordinated to existent bondholders, which means that if in the end Greece does pay 30-50 cents on the euro to the latter, European taxpayers will be lucky to get 10 cents on the euro.

The whole deal is now looking like a massive subsidy for Greece and entails absolutely no protection to European taxpayers.

But internationally, EU news are getting darker and darker by the minute. Last night Bloomberg reported that EU countries are in for estimated €600 billion bill for the fiscal crises that have spread across the block. That's the cost, in the end, of all the tacky policy follies that Brussels endorsed and pushed through over the last 10 years -

• from the Lisbon Agenda, which was supposed to deliver EU to the position of economic superiority over the US by 2010,
  
• to the Social Economy, which was supposed to deliver... well, who knows what...
  
• to the Knowledge Economy, which was aiming to turn us all into brains in a Petri Dish
• to the absolutely outlandish HIPCI and HIPCII agendas wholeheartedly embraced by the EU, which were supposed to deliver debt relief to the world's real basket cases (before Greece and other PIIGS took the spotlight away from them), and the rest of the international white elephants.

The problem, of course, is that €600 billion price tag for fiscal excesses has generated preciously little in returns (despite what folks at Tasc keep telling us about the fiscal stimulus) which means we will have to pay for it out of our long term wealth. The same wealth that has been demolished by the recession and the financial markets collapse!

Economics 23/04/2010: As Greece crashes, Finns are talking gibberish

Sometimes, it is wise for policymakers not to speak to the media. This is usually true when the policymakers have no idea what they are talking about. Case in point – FT’s story (here) about the Finnish PM backing German plan for a new treaty on tougher fiscal deficit and debt measures for the Euro area.

“Finland is sympathetic to controversial German proposals for a fresh European Union treaty if necessary to enforce fiscal and economic discipline in the eurozone after the Greek debt crisis.” Mr Vanhanen, PM of Finland, said “the priority should be to look for ways to tighten rules within the existing treaty, including the withdrawal of EU structural funds from countries that ignore official warnings from Brussels over excessive budget deficits”.

So far, so good.

Per FT, “his comments came amid the most serious crisis in the euro’s 11-year history, with Greece on the brink of a bail-out from the IMF and fellow eurozone countries. “Greek debt is not so big but there is a domino threat so we need to isolate the problem as early as possible,” said Mr Vanhanen” (italics are mine, of course).

Oops! Did he really say that? At 117% of GDP at the end of 2009, and pushing toward 130% by the end of this year, Greek debt is ‘REALLY BIG’, folks. This is precisely why Greek bonds are trading now at the yields close to those of junk-rated Pakistan!

Mr Vanhanen “insisted the crisis must not be allowed to disrupt plans by Estonia to join the euro next January and said the eurozone must keep its doors open to aspirant members.” Why not? He warned that “any delay would “send totally the wrong message” to other aspirant members, such as Latvia and Lithuania, which are making tough budget cuts and other reforms to keep alive hopes of euro entry.”

So hold on, Mr Vanhanen. You say that these countries are undertaking reforms only in order to comply with the euro entry rules, not because these are the right things to do? What hope do we, the Eurozone taxpayers, have that once admitted into the club these countries will not turn Greek? None, certainly, judging by Mr Vanhanen remark.

My humble advice – if you are a politician with no expertise in economics or finance, don’t give interviews.

Economics 16/04/2010: The incoming train II

It is a good feeling to be ahead of the curve, especially when the curve is drawn by the likes of FT. Per today's FT Deutschland report: the ECB is warning about a new crisis, a return of global imbalances in the coming years. In its monthly report the ECB warns: “At the current juncture, global imbalances continue to pose a key risk to global macroeconomic and financial stability . . . The stakes are high to prevent a disorderly adjustment in the future that would be costly to all economies.” Jurgen Stark is predicting that we have entered a new stage in the financial crisis – a sovereign debt crisis which means that “dealing with [the resulting severe macroeconomic imbalances] will represent one of the most daunting challenges for policymakers in modern history.”

My own take on the same topic was published here.

Another issue, also raised repeatedly on this blog, is discussed in Joachim Fels' (Morgan Stanley) piece on FT Alphaville (here). Fels makes a claim that countries with a high degree of inflation aversion (Germany) might have an incentive to quit. Fels suggests three warning points for the crisis to develop:

• First, any signs of moral hazard emerging in the fiscal policies in the euro area
• Second, ECB failure to raise interest rates on time to cut inflationary pressures, and
  
• Third, the political pressure rising against the Euro in Germany.

Hell, by these metrics, we are already in the midst of the euro collapse by 2 out of three measures (first and third). Alas, the second metric is a bogus one. There is plenty of evidence to show that ECB has not been an 'inflation hawk', acting often pro-cyclically before and targeting the likes of PMIs instead of hard inflation and monetary parameters. So the real question here is: What's the potential trigger for an exit?

Greece asking for the pledged money won't do. If you think in terms of game theory, once that happens in earnest (and it might be today or over the weekend), Germany will face the following two options:

1. Grant request for assistance in full and thus pre-commit itself to the common currency at the sunken cost of an exit of ca 10-12 billion euro that it will commit to Greek deficits financing;
2. Exit now, saving the aforementioned money, but destroying its political capital within the EU.

The problem is that the net cost of (1) is much smaller than the net cost of (2). And this means there has to be another - non-Greek - trigger. Italy or Spain?

Economics 15/04/2010: Greece problems back to the frontline

So, as I have predicted in the interview with BBC World Service (excerpt here), the markets have little faith in the Greeks and, indeed, in the EU’s ability to effectively underwrite Greek crisis.

Greek bond yields are now rising again on the investors’ view that German, French and Irish legislators might veto the deal. And in Germany there is a growing movement to challenge the Greek deal in a constitutional court, as being an illegal subsidy. The yield on Greek two-year bonds jumped 66bps yesterday reaching 6.99% and 5-year CDS rose 56bps to 436bps.

And FT’s Daniel Gros argues that the EU package is unlikely to solve anything, as the country needs about €30-50bn annually, depending on the future deficits path assumptions. Either way, 3-year package of up to €45bn won’t cut it. And the interest bill savings are also too thin – under the EU proposed deal, Greece will be facing an interest rate of ca 5%, which will provide the country with only €900mln in annual savings relative to market rates. Going lower to 4% - something opposed by Germany – will raise savings to ca €1,350 million per annum – still short of what is needed. Per Gros: the Greek problem is not one of liquidity but of insolvency.

And the IMF is severely constrained in what it can do in Greece by the fact that it can only lend 10-12 times the reserves position that Greece holds with IMF. And this means, at a maximum €15 billion.

So here we go – for all who thought the story is over, the most likely thing is that the actual story is just beginning.

Economics 24/02/2010: Greeks, Germany and the euro

There is a fine mess going on in Athens. And it is both

• detrimental to the Euro; and
• predictable (see here).

Exactly a month ago to date, I have predicted that Greece is going into a Mexican standoff with EU. We now arrived at exactly this eventuality (see this link to a good summary of Greek Government views - hat tip to Patrick).

Back on January 24th, I wrote:

"The EU can give Greece a loan – via ECB... But the EU will have to impose severe restrictions on Greek fiscal policy in order to discourage other potential would-be-defaulters today and in the future. That won’t work – the Greeks will take the money and will do nothing to adhere to the conditions, for there is no claw back in such a rescue.

Alternatively, the EU might commit ECB to finance existent Greek debt on an annual basis. This will allow some policing mechanism, in theory. If Greeks default on their deficit obligations, they get no interest repayment by ECB in that year. ...but what happens if the Greeks for political reasons default on their side of the bargain?

If ECB enforces the agreement and stop repayment of interest, we are back to square one, where Greece is once again insolvent and its insolvency threatens the Euro existence. Who’s holding the trump card here? Why, of course – the Greeks. And, should the ECB play chicken with Greeks on that front, the cost of financing Greek bonds will rise stratospherically, and that will, of course, hit the ECB as the payee of their interest bill.

Thus, in effect, we are now in a Mexican standoff. The Greeks are dancing around the issue and promising to do something about it. The EU is brandishing threats and tough diplomacy. And the problem is still there."

There are three possible outcomes from the standoff:

• Greece backs down and Germany accepts an apology - which pushes us back to square one, with Greeks still in the need of funds and EU still without a plan;
• Greece goes for the broke and remains within the euro, implying a rapid and deep (ca 30%) devaluation of the euro; or
• Greece is forced out of the euro (there is, of course, no mechanism for such an action).

The first option is a delay in the inevitable; the last one is an impossible dream for fiscally conservative member states. Which leaves us only with the second option.

And incidentally, the only reason German bunds are still at reasonably low yields is because Germany is linked to Greece (and other PIIGS) only via common currency. Imagine what yields the German bunds might be at if a full political union was in place?

This, of course, flies in the face of all those who preach political federation as EU's answer to structural problem of hinging desperately diverse economies to common currency.

So hold on to your pockets - after the Exchequer raided through them via higher taxes; Greek default will prob their depths through devaluation. And then you'll still be on the hook for our banks claiming their share in an exercise of rebuilding their margins.