Wednesday, April 28, 2010

Greece – GIIPS – Eurozone - Big Problem

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 EU as per the Lisbon Treaty.

Rebecca Wilder

15 comments:

  1. the second wave is already underway:

    Greek Junk Contagion Presses EU to Broaden Bailout After Rout - (Bloomberg) -- Europe’s worsening debt crisis is intensifying pressure on policy makers to widen a bailout package beyond Greece after a cut in the nation’s rating to junk drove up borrowing costs from Italy to Portugal and Ireland. As German Chancellor Angela Merkel delays approval of a 45 billion-euro ($59 billion) Greek rescue, the crisis is spreading.

    Weak Italian Bond Auction Spurs Greek Contagion Fears

    <span><span>Spain’s Debt Rating Cut, Heightening Concerns Over Europe…</span> </span>NYT
    The ratings agency <span>Standard & Poor’s</span> lowered the debt rating of Spain on Wednesday, its third downgrade of a European country in two days.

    ReplyDelete
  2. Guess Merkel is being wise - why hurry when another country's debt rating may fall. One almost needs a chart to keep track of the current ratings by country within the EU. What would it take for one to withdraw from EU as per rjs below??

    ReplyDelete
  3. Hi AJ (Aunt Jane, that is)

    Merkel's starting to understand, now that Germany is rumored to be making aid available to Greece not just for 2010, but for 2011 and 2012 as well. This is a real problem, and one that's not going to end with Greece's bailout into 2012. One cannot just point the finger at this juncture - this affects Germany as well!

    "<span> One almost needs a chart to keep track of the current ratings by country within the EU."</span>

    Totally agree - where's Spain going to be tomorrow? Greece could be D for all we know (that is default).

    Rebecca

    ReplyDelete
  4. as previously noted: german opposition to the bailout is 86%:
    <span><span>Greek instability threatens to topple Merkel's government</span></span> - Growing opposition from the German public to a planned bailout of Greece is jeopardising Angela Merkel's chances in a key state election next week and could ultimately undermine the stability of her coalition government. The country's most populous state of North Rhine Westphalia goes to the polls on 9 May.

    <span>Roubini: "In a Few Days time, There Might Not Be A Eurozone For Us To Discuss"</span>

    ReplyDelete
  5. rj,

    Good to see Doom is still hanging in there! The problem is that by pushing the aid package back past the election date (May 9, I believe) - as you mention this is very unpopular in Germany; I should know, I live with a German - the risk of a financial contagion followed by an economic one rises. Restructuring must occur, and then the governments need address the unstable construct of the Eurozone (fiscal and not monetary sovereignty).

    <span><span>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.</span></span>

    Rebecca

    ReplyDelete
  6. yes roubini is certainly in his element here......trying to return to
    normalcy seems to be a lost cause...the thought that comes to mind for this
    situation is battlefield triage...separate the entities into those that can
    survive on their own without aid, those that need immediate help, and those
    that are are hopeless cases...
    On Thu, Apr 29, 2010 at 6:11 AM, Echo <
    js-kit-m2c-UNKPUINH6VQDA6HPKF5SG35VR5LQDSDVFQ6R9UKCQNF7LJOEMIC0@reply.js-kit.com

    ReplyDelete
  7. Nobody talks about this – but Greece can secede from the <span>EU</span> as per the Lisbon Treaty.

    The Lisbon treaty probably re-introduced the Death Penalty exactly for that :-D

    It's not the Germans who are in trouble, it is the France and the UK. No sensible German want to throw good money after bad to help, neither the Greeks nor the French but The Banks. Those people who has just been bailed out and rewarded themselves handsomely for their investment acumen ...

    Any politician that keeps ignoring the anger about the bailouts and the job losses while the bankers gorge themselves will a) lose big at the next election b) have people like Jobbik in parliament - and 'b' is worse than a few bankrupcies, its not like anyone will starve.

    ReplyDelete
  8. <span>
    <p>GIIPS?
    </p><p> 
    </p><p>Try PIIGS. These countries are "PIGS" because their politicians have maxed out their metaphorical credit cards. They have overspent while lacking the means (productive private sector economic growth) to pay for the spending orgy.
    </p><p> 
    </p><p>All of the Greek greedy have run Greece into the ground, from government workers demanding and getting ever higher pay while doing fake work (shuffling papers) to welfare collectees demanding free cash at a rate as if they were working, successful business executives.
    </p><p> 
    </p><p>Moronic Greek politicians believed borrowing could go on forever while the babbling priesthood of clueless Ph.D. economists (overwhelmingly Keynesian) concocted falsehood after falsehood to justify the orgy.
    </p><p> 
    </p><p>Greece yields an instructive example of an economic death spiral, of what happens when a Public Sector leeches off a Private Sector through taxation and regulation championed by clueless Ph.D. economists until the point of no return.
    </p><p> 
    </p><p>All economic action and retardation in Greece arises solely from rules set forth by Greek politicians, all guided by court economists. Thus, the responsibility for this mess rests with them alone. Greek politicians misled their dopey citizenry who greedily demanded for ever more while trying to stick someone else with the bill.
    </p><p> 
    </p><p>Calling them GIIPS amounts to an insult to Romany gypsies everywhere.
    </p></span>

    ReplyDelete
  9. Some good news when we appear to be hearing much not so good news, while the the Consumer Confidence Index has increased the stock market is still having a hard time to maintain its position. Recently, it dived below 10,000 Thursday afternoon as investors cowered in fear of the European debt crisis and escalating hostilities between North and South Korea. It's uncommon for the stock market to decrease and the consumer confidence index to rise, but that's what is occurring. The two usually follow the same path. Job openings are one of the reasons that consumers are creating a better outlook of the future. Even though the unemployment numbers are changing dramatically the consumers seem to have a much better outlook for the future. The only downfall of this survey is the fact that it was done between May 1 and May 18, indicating that the recent stock market declines may have changed people's views. In addition the Korean wars and also the European debt crisis may have decreased the consumer confidence index and we might not even be aware today.

    ReplyDelete
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