Wednesday, 25 May 2011


Greece would 'drag everyone down' if it defaults on its sovereign debt, and that is what the European Central Bank (ECB), among others, argues. However, there are many different views in the EU about what is best, because there is no such thing as 'best', considering that no matter what some social group would be hurt no matter what policy is followed. Of course Greece cooked the books, but this was with the complicity of Goldman Sachs and with the knowledge of the ECB and other EU institutions. 

Bloomberg news services filed a law suit against the ECB to open the books on Greece, so that the world can find out what was the role of Goldman Sachs, to what degree did the EU officials and ECB know of what Greece was doing, to what degree was the US pushing from behind the scenes to have Greece join the Eurozone. While it has been illegal for EU governments to use derivatives as a means of showing the debt is much lower than it actually is, it is up to member states to have an open and transparent method.

The ECB refused Bloomeberg's request. A few insiders argue that if the ECB and EU open their confidential papers on Greece, what the world will discover is that other countries also were in a similar situation as Greece, and that the decision to let them join the Eurozone was political not economic. This is a tragedy of collective responsibility on the part of European officials.

The question everyone asks "will Greece default?" There are a number of fund managers in the US and EU that have enormous amounts of money riding on this very issue, and it is their right under the rules of capitalism to risk their capital to make money on the possibility of a default. European banks (German 19 billion, French 15 billion euros) are carrying about 50 billion euros worth of Greek debt, and Greek banks another 50 billion.

This is paper that they can only hold, because the prospect of default is too great for others to buy it even at low prices - the 10-year bond selling at a 50% discount. European banks holding Greek debt would not have a problem passing the periodic stress tests, but as time passes, the Greek debt picture deteriorates and the prospect of restructuring or default increases. In two-and-a-half years, 90 billion euro of Greek bonds will mature and that is roughly one third of Greece's GDP, which EU and IMF will have to fund in order to pay the bondholders.

Because the ECB also holds bonds, as does the Greek central bank, insurance companies, and pension funds (more than 170 billion euros), it is in their interest to avoid default or restructuring that would mean recapitalizing Greece. The amount would depend on how much public property is privatized, how far the austerity measures go, how the economy performs.

I believe that absolutely no one knows the answer to the question of default, because at any time major players - ECB, IMF, Germany, France, others - can step in to stop what may appear as the inevitable. That the numbers simply do not add up (there is no way that Greece can service the debt that could easily go to 200% of GDP within the next two years) is a realistic prospect.  But what scenario will play out is a guessing game for those wishing to play with the bond market. The consequences for the euro will be negative. 

Even more ominous is what this means for Ireland, Portugal, Spain, and perhaps even  Belgium and Italy. On 25 May, the OECD announced that: "Even if the governments (Ireland, Greece and Portugal) are more or less on track to meet their fiscal targets, their fiscal positions would not be sustainable if market interest rates were to remain for long at their current level."

The pessimism stems from the reality that economic indicators (higher inflation than it should be for nations under austerity, higher debt-to-GDP ratio, higher unemployment, lower productivity) do not look good for the Eurozone periphery and will not improve in the inter-mediate future. It will simply be very difficult for Greece and the other periphery countries to float bonds in the open market as long as such conditions exist, and that spells no light at the end of the tunnel at this point - May 2011.

That the ECB opts for a wait and see attitude as it has strongly indicated, is indicative that it wants to make sure the austerity measures go as far as they can politically, before there is a decision about the next step (s). That step (s) could be anything from the pragmatic option of more loans and restructuring to the more unlikely scenario of transition Greece out of the eurozone. 

Political events in Greece could decide the fate of the public debt long before the ECB, IMF, EU, central banks and private banks. Inspired by Spain's Puerta del Sol protests in Madrid, Greeks not belonging to any political party have organized similar protests against the political and business establishment. The other player in the mix could be China. Holding the largest reserves in the world, China is in the position to buy bailout bonds in the EU market. It has just made such announcement with regard to Portugal, thereby taking off the pressure from the EU, ECB and of course helping to strengthen the euro that helps China's exports to the Eurozone.

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