Wednesday, April 28, 2010
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.