The Greek Squeeze

I feel like I am living in a “Choose Your Own Adventure” book. What global shock comes next? The air of uncertainty remains. This morning an imminent (but questionably so) bailout is across the news wires. From the WSJ:

Germany is considering a plan with its European Union partners to offer Greece and other troubled euro-zone members loan guarantees in an effort to calm fears of a government default and prevent a widening of the credit woes, people familiar with the matter said.

and later…

It is unclear how the debt guarantees under consideration might be structured, but with any aid, the EU will be walking a delicate line between forestalling a greater disaster and letting chronic overspenders like Greece off easy, which could further damage trust in the euro.

“As long as it is very clear that any support only comes with very, very stringent conditions attached, it would not affect the moral-hazard question,” said Fabian Zuleeg, chief economist at the European Policy Centre, a Brussels think tank. Still, he said, “It is a choice between two evils.”

Obviously, markets see this deal getting done, however, you know what they say about the fat lady… This morning 10-yr bond spreads over German bunds were down across all of the PIIGS countries, where Greek spreads dropped almost 100 bps over two days (76 bps now).

The moral hazard implications are clear. If Germany bails out the Greek government – the Greek government has a €53bn financing needs this year – then what next? Saving rates in Europe look a little bi-modal, with the big savers clustered at the top of the spectrum, Switzerland, Austria, Germany, and Finland, and the big dissavers at the bottom, Portugal, Greece, Italy, et al.

Spain and Italy account for 29% of 2008 Eurozone GDP and Greece just 2.5%. Spain’s debt metrics pale in comparison to Greece’s (see WSJ link), but remain well outside the Maastricht Treaty limits. Allowing Spain and Italy to fail is obviously “too big”.

Another question out there is future membership requirements. Bulgaria (not currently in ERM II)? Latvia? The benefits to joining the Eurozone are obvious (there are costs, too, like relinquishing monetary autonomy); notice how Greece’s borrowing costs plummeted following its 2001 venture into the Eurozone. S&P upgraded Greece’s rating from A- to A in March 2001.

Skepticism over the Eurozone will likely last for some time. Two days ago, the FT ran an article titled Traders make $8bn bet against euro – sentiment is very negative, and the EUR/USD is off around 9% from its 2009 peak (November). Although key economies, Germany, likely welcome a weaker euro, the region as a whole is certainly being tested.

Personally, I think that the IMF should be involved. But here’s a great piece over at the Baseline Scenario listing why that is not a possible/probably outcome. Hmmm, wonder how China and Japan will react to this news? Yup, buy dollars.

Added link: You all might find this article interesting.

Rebecca Wilder

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