Greek Default?

By Allston Mitchell, March 1, 2010

The good old days?

The good old days?

Could Greece be the first EU country to default? The structural inadequacies of the Euro have never really been put to the test. The ECB has never been in the position to have to bail out a member state to save it from bankruptcy.

Back in December 2009 the news emerged that Greece was in serious trouble. The country was severely in debt and was nowhere near to maintaining its 3% limit of debt to GDP that the Eurozone insists upon to maintain stability in the single currency. At the time it looked like the debts amounted to 30 billion euros and now the figure appears close to 53 billion euros.

There were accusations that Greece had been cooking its books and supplying the EU with dodgy data but it is unlikely that Greece’s current dilemma came as a surprise to the ECB or the Commission. Nevertheless, the 3% limit was a fairy tale, the real number looks closer to 12%.

It is clear that Greece is in trouble but the larger question is what is the rest of the world going to do about it? As things stand the EU is trying to talk up a generalised solution that commits nobody to anything and slowly shifts the crisis away from the cliff edge. That has not fooled anyone, particularly the financial markets which are not known for their sentimental side.

The main question is: would a bail out or a series of bail outs be worse that having Greece as a country default? There is no answer to the question at present. It is still unclear what the EU plan is trying to save, is it just Greece, the other countries like Portugal, Italy and Ireland and the Baltics too for that matter who would theoretically come under the spotlight if the dominoes started to fall. Or are they trying to save the entire structure of the single currency? What is the focus?

Nobody is really sure. One view is that Greece will receive a hitherto undisclosed financial package that will restore investor confidence in the country and in the future of the Euro. This basically means a loan. No gifts though, everyone seems clear on that. Greece is going to have to take a very short haircut and indulge in some serious self flagellation mainly for the benefit of the donors who wish to avoid being seen as setting a precedent for bleeding heart liberalism.

The Armageddon view is that Greece will be left to default and a domino effect will be set in motion with the financial markets speculating on the various Achilles heels of the Eurozone. This could lead to a complete break up of the Eurozone and financial chaos.

Somewhere in between there might be a moderately radical solution such as Greece opting out of the Euro for a couple of years while the country sorts out its finances.

All eyes are on the ECB and the European Commission as it is only a matter of time before the bond and currency markets and the CDS market throw out the baby with the bath water and ditch the Eurozone in its entirety rather than just its rotten parts. A firm decision has to be forthcoming soon.

This too is a problem as the EU has no wish to actually commit to a bailout. Greece in this sense has the EU over a barrel. The old cliché about if you owe the bank 1,000 euros it is your problem but if you owe them 1,000 million it is the bank’s problem is very apt here.

This is where politics comes into play. Everyone is waiting for Angela Merkel, the German Chancellor to write a cheque and bail out her profligate Greek cousins. This for her would be political suicide. How on earth would she explain it to the average German voter?

Politically, Greece needs to be seen to be taking a punishment if only for appearances sake but violent social unrest in Greece is never far from the headlines. There have already been huge demonstrations in Athens against the EU package, even before its announcement. The Greeks can smell trouble and most probably unemployment too. It is a tricky question. Undertaking massive cuts in Greece would be like starving a dying patient of oxygen.

Who is fundamentally responsible? Obviously Greece is the main culprit but looking back just ten years there was a bevy of economists who foresaw just this eventuality when the Euro was created. It was too early, they said, and the single currency had too many structural weaknesses. The EU was in too much of a hurry that it closed both eyes when assessing countries’ suitability to accede to the Eurozone. Greece was not alone in cooking its books prior to accession, they have however been the first to get caught, but political idealism and expediency won the day and now the bill is being presented.

The EU is a fairly solid commercial union but politically it is embryonic with a complete fudge for a parliament filled with political has-beens, dodgy characters and cronies who are quite simply a pointless luxury. Creating the single currency was a clever way of trying to bypass this lack of a political union but that was unsuccessful. Countries are still completely responsible for their sovereign debt, try as they might to throw their garbage into their neighbours’ yard.

Saving Greece is one problem but who will save the Euro? The Euro has structural weaknesses, predominantly the fact that major players (the UK primarily) are not participating and the fact that the ECB has a limited mandate, it is in charge of price stability only, not for solving unemployment problems or recessions with emergency financing for example.

Times have changed, southern European countries prior to joining the Euro were in charge of their own fiscal policy which they could adapt to their own needs. They are now slaves to the bond markets which pronounce judgement on them every minute of the day. There is no longer an option for selective currency devaluation to kick start exports. Ask any Italian.

So who is going to pay the bill? First of all the Greek taxpayer and the Greek unemployed. Then most probably the EU taxpayer with some sort of a loan from the ECB, albeit a reluctant one.

The spectre of a sovereign risk debacle is too great, it has been hovering under the surface of the world economy for at least 18 months, from California to Athens.

The bond markets await, like hungry hawks.

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