Greece – GIIPS – Eurozone – Big Problem
O.K., Greece is now “high yield”, “junk”, “below investment grade”, at least according to S&P. What I mean by that is S&P now rates Greece’s foreign and local currency sovereign debt at the BB+ level (with a negative outlook), below the sometimes-coveted investment grade status, BBB- is the minimum. Why did S&P feel the need to do this now? Just covering its _ss – Greek debt was rated A- as recently as December 2009.
On to the Germans. What they are doing is actually quite striking: offering a bailout in order to appease markets so that international investors will pick up the Greek bill (never was going to happen anyway); and then telling markets that bond investors in Europe will take a haircut so that international investors won’t pick up the Greek bill. I guess the light-bulb finally went on that there is a contagion brewing here because bunds are tight, while all Peripheries are wide.
The original bailout will likely be offered to satisfy Greece’s near-term obligations. However, in the meantime the probability that the liquidity crisis spreads across the GIIPS (Greece, Italy, Ireland, Portugal, and Spain) – especially Portugal with a 2009 current account deficit equal to 10.3% of GDP, making it shockingly susceptible to capital outflows – is rising.
We’re in crisis mode – the calm before the storm. I see the Eurozone disaster happening in three waves:
First, there is a liquidity crisis in Greece (already underway).
Second, it turns into a full-fledged financial crisis for the GIIPS. The capital account drops precipitously with investor confidence in GIIPS markets, leaving the very vulnerable countries, like Portugal and Spain with current accounts very much in the red, seriously short of cash.
What Germany wants out of Greece (and any bailout thereafter) is the equivalent of an economic anaconda. It will force Greece to meet the limits of the EMU Stability and Growth Pact (3% of GDP) by some period, let’s say 2012.
Of course that cannot happen without an epic surge in exports. Here’s the death spiral: sharp austerity measures translate into unemployment, economic contraction, deflation, and yes, higher deficits. There’s just no way out of it.
So what is the be all and end all policy script? Regain competitiveness in world markets, no less. The Economist on Portugal:
Low growth reflects a disastrous loss of competitiveness since the country joined the euro. Portugal has lost export-market share to emerging economies (including those of eastern Europe) that churn out similar low-value products. This is largely due to a steady rise in unit labour costs, as wage increases outstripped productivity growth (see chart).
The IMF’s consultation on Italy, as per its latest Article IV report:
Economic rigidities, along with Italy’s specialization in products with relatively low value added, have also been contributing to a steady erosion of competitiveness. Consequently, Italy has been losing its market share of world trade.
And my favorite part of the Italy Article IV:
In the past, other countries have overcome similar challenges from very difficult starting positions with comprehensive policy packages.
Note the very incriminating term, “comprehensive”. That usually includes expansionary monetary policy and the depreciation of a currency to drive export income, both of which elude any of the GIIPS countries.
The Economist portrays Portugal’s path away from depression-land via export income by lowering ridiculously high labor costs (i.e., productive labor as measured by the unit labor cost index) relative to those in Germany. As such, Portugal should be able to pick up exports while the government drops the deficit and constricts domestic demand. Notice the catchy title!
But what they fail to illustrate is the fact that all of the GIIPS are in EXACTLY THE SAME UNCOMPETITIVE BOAT!
So we get to the final stage, GIIPS go depressionary, and the economic contagion spreads across the Eurozone, hitting yes, Germany. Notice that Ireland is the only GIIPS with a fighting chance, according to the Eurostat’s forecast.
I’m married to a German – I understand stubbornness. But this time, being stubborn is just going to get the Germans in trouble.
The GIIPS are 34% of Eurozone GDP – try to export your way out of that one when 1/3 of the “Zone” is reducing costs and cutting wages. It’s a fallacy of composition to assume that the GIIPS are cutting spending while the aggregate remains intact. Furthermore, each EU country exports an average of 68.6% within Europe, so Germany’s clearly going to feel this, too – at least if the “Zone” gets past the immediate liquidity crisis.
Nobody talks about this – but Greece can secede from the Eurozone as per the Lisbon Treaty.
Update: It should be noted that Lisbon allows a country to leave the EU, of which the Eurozone is (effectively) a subset.
It´s not german stubborness. It´s a rational assumption that greece can not repay their credits. Therefore it´s not neccessary for the german goverment to bailout the greece.
Also you ignore that a bailout is illegal under european Euro treaty. Did any English read this treaty?
There is one way out IMO, Greece, Portugal, and Spain must lose the Euro. Their debt loads are too big. The debt involved is as big, if not bigger than our recent banking problem here in the US. The UK looks down right brilliant right now for not adopting the euro.
Are you German? Those stipulations were written at the onset of the European Union Treaty, but now we’re WAY past laws, limits, and rules (“rules” is referring to the Stability and Growth Pact). This bail-out must happen at the government level, i.e., Germany and France must stem this crisis, in order to officially address the system’s vulnerabilities. That, of course, includes short term bail-outs; but longer term the issue of fiscal consolidation must be decided, the construct of the Eurozone is unsustainable: one currency to rule them all.
In the meantime, there is a very growing possibility of a run on the banking system. Imagine the Irish government – the deposit liabilities of its banking system are like 600% of GDP – insuring a bank run, now that’s insolvency. My point is that the time to adhere to rules is not now; and in fact, the “rules” should change.
The Eurozone was never meant to withstand this type of pressure. It’s buckling, and only a matter of time before the financial contagion turns into a depression and spreads quickly. So yes, I do think that the German stubbornness is the “wrong” course of action. In fact, its neither wrong nor right, taxpayers are going to pay for Greece either way – financially or through a loss of real activity – whether it defaults, restructures, or is rescued.
“Nobody talks about this – but Greece can secede from the Eurozone as per the Lisbon Treaty.”
Sadly, no. If you leave the euro you also have to leave the EU.
My best guess is a default and restructuring by Greece. The only question is when….this year or in two or three?
Beware of Greeks gifting bears.
True. I thought that was implied. Thank you for clarifying, though, Tim. Rebecca
I think they default this year. Heck, their debt numbers have just been revised a second time (upwards), and they cannot afford the interest payments on the new debt.
Could the big guys be looking to create a “china” region within their little kingdom there, for going the US route of job export and not have to deal with China’s power?
Sounds awfully similar to the policy talked about in the Shock Doctrine regarding helping failing countries to become “prosperous”.
I´m German. But I think the problem is much more complicated. It´s also another failure of the rating agencies, which presumably can not predict future financial problems of subprime rates or other countries calamities.
Also there is a giant corruption problem in Greece. I have read that every Greek pays 1400 € for bribes per year at average. It´s amazing, that there are no concrete dates of how much money the Greek Government really needs. These are not simple statistical errors. This is highly criminal fraudulent behavior. I miss criminal investigations and I want to see the responsible persons for such frauds arrested and indicted. This differs from the situation in all other south-european euro-nations.
And I don´t think, there is a real problem for the Euro, if Greece goes bankrupt. The Greek proportion of the European Economy accounts for only 2 – 5 %. It´s comparable to the situation in the USA. If the State of California, a much bigger economy, goes bankrupt, I would also see no problem for the Dollar in the long term.
***Sadly, no. If you leave the euro you also have to leave the EU. *** Tim Worstall
What would the consequences be if the EU decided to change that?
Can Greece(Portugal/Spain/Italy/Ireland/etc) leave the EU, default, clean up its(their) finances then rejoin either using their own currency or the euro?
Is there any conceivable mechanism for a country using the Euro to effectively devalue its currency?
How the hell do other currency unions like the US or Canada manage to function without numerous states/provinces defaulting on their debts every time there is a recession?
We have had defaults in the past (NYC, San Diego), but with states and localities most must balance their budgets, so we genrally avoid the problem. If say CA were to “default”, the Federal government has 2 options, some sort of bailout or let CA deal with the problem. CA has much more room to raise taxes than Greece does. If the Feds bail out CA, then you will have a big moral hazard develop, and more states will follow suit.
It seems to me that there should be more discussion about what percentage of global aggregate demand has been reliant on unsustainable debt levels and artificially inflated asset values over the past decade or so. Where would Japan be now for example, with its GDP to debt ratio of 200%, if the rest of the world had kept its debt levels and asset values at sustainable levels. Then too, where would global aggregate demand be, in relation to global output capacity or acceptable unemployment levels, if not for the unsustainable consumption levels? Or, if an even more stark view of reality were needed to show just how poorly the global economy is functioning, the gains that are the result of developed nations exploiting undeveloped nations could also be deducted from the equation. According to Dr. Stiglitz for example, for every dollar that the developed nations spend on aid they receive a return of 3 dollars in net revenues. Dr. Stiglitz also uses some small African country as an example, (I don’t remember which one), in which the general population receives as little as 5% of the value from the natural resources that are being exported from that country. Then too there are more than a billion people on the planet who are malnourished. So, the point is, by looking at the problem in terms of this nation or that nation, it seems to me that we run the risk of running the global economy into the ground, so long the rich and powerful global sect is allowed to insulate itself from the truth. And the truth, even though it is well beyond my math skills, does not seem all that difficult to show?
I thought Britain is part of the Eurozone from a trade/import duty standpoint, but of course retained their own currency that they can slowly (or not so slowly) destroy, and that is what makes economics work so well.
The option Greece has to effectively re-val under a strong currency is to cut wages/benefits and get competitive with the world(although this may mean becoming a tourist destination rather than challenging Porsche in the automotive sector). But economists are always quick to point out that this causes lots of yelling, screaming and riots, so the good way is to quietly screw everyone with a currency re-val. But then we have the problem of the whole world trying to use the same medicine and we get the fiat currency race to the bottom.
Also, we can’t underestimate the impact that banks will have on the eventual bailout decision. They will hold a gun to their heads and say that without a bailout, we are all dead! I’m getting tired of hearing that one, even if it may be true.
To be clear, the Eurozone as a whole cannot decide to provide a bailout, and the ECB cannot, but individual governments can. That is what’s happening, so the “no bail-out” provision is not being challenged by current efforts to aid Greece.
While it is possible to Greece to leave – even if there is no provision to do so, Greece is still a sovereign country – that solution brings peril’s of its own. All contracts which specify payments either assume euro payments or specify a currency. There was enormous effort put into rewriting contracts and other formal obligations as Greece prepared to enter the EMU. Leaving would mean undertaking a similar effort. Greece could simply announce the institution of a central bank and bring bach drachma’s overnight, but it would create pandemonium. Making such a conversion in an orderly way would wreck Greek banks, because the obvious presumption is that the drachma would either convert at a disadvantageous exchange rate, or fall to a disadvantageous exchange rate over time. Depositors would move accounts to banks outside of Greece to avoid the loss.
The euro is to a very great extent a one-way gate. It is possible that Greece will enter a situation in which jettisoning the euro is the best option, but that would necessarily mean all other options are dreadfully, sickeningly bad. By the way, shedding the euro means leaving EMU, but not the EU.
It is obvious that policy thinking has shifted from whether to save Greece and prevent “bad things” for EMU, to how to save Greece, because it will probably be cheaper than bailing out banks all across Europe during a continent-wide recession. The loss of trillions in output and hundreds of billions in revenue, while paying out hundreds of billions to shore up banks – that is an entirely plausible option to helping Greece.
Now, the question of debt restructuring has been raised in the German parliament. It makes sense, if there is going to be a restructuring, for aid donors to hold on to their money till the restructuring is complete, since aid money will go a lot further to deal with a reduced level of debt. If there will be a restructuring of debt, sooner is better than later. Restructuring of debt, though, brings us back to trouble for banks. They are the major holders of Greek debt. In a practical sense, restructuring is an “alternative” to default – that is to say, an organized, negotiated for of default. Only if default of some kink is inevitable is restructuring likely to be chosen. I think default looks pretty close to inevitable, but what do I know?
Good point. If Greece gets a bailout, we have officially supersized “moral harard” to a sovereign size problem.
The IMF of course is very familiar with this problem, and somehow tries to get tough on governments that they give bailout loans to, but I’m really not sure how they enforce a “no crooks policy”.
I don’t have any numbers to back this up but… I don’t think Greece needs to raise taxes so much as it just needs to collect taxes. This is not an important distinction but the situation in Greece is not all that similar to that in California. The one thing though that does make this worth mentioning is that some folks have argued that Greece should be bailed-out with no consideration given to what is corruption on a huge scale. Greece is providing an example of what happens when cronyism is taken to an advanced stage and this is more than just worthy of mention, it is possibly a warning of what to expect as things worsen.
What you are getting at in your question:”How the hell do other currency unions like the US or Canada manage to function without numerous states/provinces defaulting on their debts every time there is a recession?” Is the central question of Federalism and of course we fought our Civil War in an effort to answer that question. Finding a way to distribute power, so as not have it too concentrated, while also having what the EuroZone does not have: political sovereignty, is a feat that only the USA has managed to hold in the necessary balance. That said, I seriously doubt that the EuroZone will function in a cohesive and efficient manner. That also said, I think your suggestion that some structural changes need to be made… is accurate to say the least. Europe’s history is almost nothing but a story of conflict, and it is surprising that Europeans did not learn more than what they did, evidently, from our struggles with the distribution of power issues.
The way we do it:
1) Issue more muni bonds and “general obligation” bonds. They are insured, and we don’t worry (that much) about whether muni insurers are adequately capitalized. I hear financial pundits say all the time that munis and states won’t default,,,they will be bailed out or will raise taxes or the muni insurers will be bailed out. (I don’t take this advice, however)
2) Federal aid to states. We call that “stimulus spending” now.
Agree. Greece either needs way more revenue or cut costs. I do not think they will manage the latter, whcih is why I belive they will default at some point. My CA comparison is only that CA has room to raise taxes, whereas Greece does not. So CA is in much less danger.
My point was that Britain maintains their own currency so they can print money to meet debt obligations, and why they look smart for not joining the Euro currency.
The first eight decades of the US, the federal government was very weak. Weaker than the EU today in many ways. AFAIK, the only state that defaulted was Mississippi sometime around 1840 and nobody tried to bail it out. I believe that a lot of commerce back then used local banknotes rather than the national currency. Maybe that makes a difference. Or maybe it is the dependancy of modern commerce on a few currencies and digital connections.
Anyway, it would appear that sooner or later the EU needs to figure out what to do about this mess and others to come, even if it means abandoning the Euro or reducing it to a reference currency with the EU countries operating in local currencies pegged to the Euro with pegs that can be changed when absolutely necessary.
It doesn’t appear that economists understand this stuff very well, does it?
An interesting solution proposed by a French economist yeasterday: Cancel all military expenditure and immediately cover the budget deficit. (And risk another coup d’état by the Colonels?)
Another proposed by a Greek economist last year in order to collect taxes: Outlaw all use of cash or checks and give every one a credit or debit card.
They don’t, and now and then you find one that admits it, but that is rare.
But about the Eurozone going off the euro, or using it as a reference currency. This is quite humorous, because the problems europe had before the eurozone where these:
1) Bizarre trade and tariff protections stifling trade and and adding cost.
2) 16 different printing presses running at various speeds. Most on the MAXIMUM setting.
3) Borrowing costs were high for consumers, biz and government in the countries with weak currencies. Which were all of them except Germany, Swiss, and maybe France.
So now the “fix” is to go back where they were? How funny.
I laughed at this lead off statement in a Barron’s article released Monday afternoon:
“As the Dow continues to defy the stream of downgrades in European sovereign debt — Greece and Portugal yesterday, Spain today — the conditions are spinning more and more beyond anyone’s expectations on the continent.”
The Europeans are going to get their heads kicked in over this one. Dumb as dirt, that crowd.
The dominoes are going down and the damage will spread well beyond the PIIGS.
“Eurozone” means uses the euro as the national currency – membership in the European Monetary Union. “European Union” means membership in the common trade zone. All nations in the EMU are in the EU, but not all nations in the EU are in the EMU, with Britain an example of this latter class.
Sort of a hollow taunt, isn’t it, to claim that economists don’t understand this or that, merely on the strength of your own opinion? Care to offer the slightest shred of evidence that economists in general don’t understand these matters are well as you? Cause if you are holding up a higher standard than your own understanding, you wouldn’t really know whether economists understand the issue, would you?
By the way, I’d like to exclude Mundell from consideration. He really doesn’t seem to understand.
Odd that you claim to agree that economists lack understanding of the currency situation in Europe, then follow it up with the claim that prior to monetary union, the relevant European countries had “Bizarre trade and tariff protections stifling trade and and adding cost.” Monetary union followed decades of economic union, under which tariffs were eliminated and non-tariff barriers were normalized across the EU. Monetary union was aimed at eliminating the last major barrier to trade within the EU, and came well after other major barriers were gone.
It’s kinda funny to see people pontificate about the poor understanding among economists, while at the same time demonstrating a misunderstanding of their own so profound that judging the understanding of others is simply impossible.
What is it with the giddy, ad hominem attacks against economists?
It’s mainly because so many economists get all huffy when you threaten to take away their printing press, but are usually fine with governments taking away investors’ money, or paying low interest rates because they have a stable currency, then running the country into the ground anyway, then the solution is re-val, or change the currency that the bonds are denominated in, or an international bailout to save the banks, or default….
And then economists want to tell us they have perfect understanding of the economy? Not relative to me, lets try an absolute standard.
And my understanding of the issue is not “profoundly” inaccurate. It was pretty much the way things were described in the mainstream media when the EMU and EU where annouced. I did use the “eurozone” word too loosly but this was a blog post, not a legal document. And here is Wiki’s attempt to put it in one sentence:
“Full economic and monetary union has been in effect since 1 January 2002 for twelve countries, with further members joining since. For the European Union, economic and monetary union (EMU) was established in three phases: coordinating economic policy, achieving economic convergence (that is, their economic cycles are broadly in step) and culminating with the adoption of the euro.”
So that was my bullet point 1). Points 2) and 3) I also read in the press, or saw on TV, or heard from my relatives in Germany.
BCA, a Canadian firm, published an interesting report a few days ago which highlighted how a collection of Northern European countries and Greece got out of similar problems in the 80’s and early 90’s. With the exception of one case – Greece – all of the countries got out of their deficit problems through a series of spending cuts. Greece on the other hand reduced its deficit through revenue (tax) increases. There are two implicit points. First, it is quite possible to get out of this sort of mess. Second, spending decreases are preferable to tax increases.
quais os principais investimentos existentes no mercado?
qual o perfil dos investidores no mercado financeiro?
por favor alguem comente sobre a atual crise economica provocada pelos GIIPS
quais sao os mecanismos adequados para os investidores resguardarem as suas posiçoes em momentos de crise?