Wednesday, October 9, 2013

Revisiting the Euro and the Grexit

Less than a year ago, we expressed our doubts about the scenarios for Greek austerity.   We said, "It's hard to see a scenario continuing where the Greek government keeps wearing sackcloth and ashes, begging for more relief.  They can never achieve the 4.5% GDP target even in 2016.  What is the point of this two year long multinational charade?"

Now we know that the Directors at the International Monetary Fund, when they implemented the Greek bailout in May 2010 knew that it was a charade, based on minutes of meetings viewed by the New York Times.  According to the Times, one-third of the forty voting Directors worried about the "immense risks" of the bailout, and the consensus was that it would not be feasible without demanding concessions from the creditors.  This demand was never put on the table.  Why?

French banks, like BNP and SocGen, and German banks like DB and Commerzbank were among the largest private creditors to Greece and didn't want to take the balance sheet hits at a time when capital adequacy and the need for bigger equity cushions might be demanded of the banks.

So, Dominique Strauss-Kahn opined, according to the Times, that there was "no doubt" that the Greek bailout would succeed.  He was not available for comment. Christine Lagarde, the IMF's Managing Director since 2011, had her eyes on that prize and needed to have a public success, even if was doomed to fail. When asked about the failure today she notes, "We had no clue that the overall economic situation was going to deteriorate as fast as it did."  It's nice to admit that you were clueless, but it's also hard to believe.

The Greek GDP has contracted by 20% since 2007, according to the Economist.  The austerity programs took the primary budget deficit (w/o interest payments) from 10.5% of GDP in 2009 to 1% of GDP in 2012. The revival of the economy can't come from the consumer sector, as the Greek unemployment rate of 27.2% is the highest in Europe.  Exports can't make up the difference, nor can increased direct private investment because of an antiquated Greek legal system that doesn't offer adequate protections.  The Greek bureaucratic logjams in the ports has been relieved, but it's still not on a par with those of the core countries.

As reported in the Wall Street Journal, Citigroup's economic forecasts for Greece are disheartening, and on another planet from those of the IMF, the ECB and the EC.  Citigroup sees the Greek GDP contracting by 11.8% in 2014.  They may be directionally correct, but let's hope that they are being too pessimistic.  There will be political blood in the streets under this scenario.

What are some of the reality bytes from all this?

  • The European monetary system still has fundamental design and execution flaws that make it unstable in most environments;
  • It offers peripheral members few real benefits except access to easy credit; 
  • Unless the peripheral countries undertake real economic reforms, the austerity medicine may make the patient better, if it hasn't killed him first;
  • French, European and Italian banks need to take their medicine and acknowledge the diminished economic values of sovereign debt on their balance sheets;
  • The continuing struggle for EU power between France and Germany is very analogous to the struggle between our two sides in Congress.  Despite all the nice rhetoric and the ECB posturing, their divergent interests still limit the effectiveness of the monetary union. 

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