Tuesday, 5 July 2011


In the 19th century the colonial powers placed China, the Ottoman Empire, Egypt and other underdeveloped countries under financial control as a first step toward colonization. In 2011, the EU has proposed a similar process for debt-ridden Greece, and it has admitted that the small Balkan nation will enjoy only limited sovereignty. This is 21st century-style neo-colonialism that is a model for how the EU will be dealing with debtor countries that it bails out. Bailout will entail loss of sovereignty.

The 'Federation Bancaire Francaise' (FBF) 'supplementary bailout plan' is designed to ease repayment of the Greek debt by rolling it over. The ultimate goal of the FBF plan is to reduce debt service for the near-term so that Greece can implement the austerity and privatization measures, a scheme that can only take place with unavoidable 'haircuts' (trimming of the principal) thus offering the bondholders lower value for the paper that they are holding. Considering that 70 of the total Greek public debt is held outside the country, a good percentage by French and German banks, the FBF and European Central Bank (ECB) have ruled out default, simply because the consequences for the euro and the EU economy would be devastating.

Standard and Poor's has already announced that such a plan constitutes a form of default and it plans to rate Greek bonds accordingly. The other two rating houses, Fitch and Moody's, have announced that they too plan another downgrade for Greece, sending the signal to financial markets that Greece will be unable to service its loans. Public debt at $480 billion or 165% of GDP, or $43,000 for every one of the 11 million Greeks, means that it can only rise in the next two to four years, before it begins to decline.

A second bailout that may be worth between 50 and 140 billion euros is currently under discussion; this after IMF-EU already committed 120 billion euros in the package of May 2010. In order to proceed with the remaining tranches (65 million) of the first loan and to secure a second one, Greece must introduce even greater austerity measures that will result in further negative GDP growth currently running above -4%, or the equivalent of what Greece pays in interest for for the IMF-EU bailout loans. 

China has expressed an interest in European bonds from the secondary market to help out, but Germany has been skeptical about the offer, because it carries even greater Chinese influence in the EU. The situation appears even more sensitive regarding the Chinese offer, because Japan has heavily invested in Italy's banks and government bonds; a situation that appears very volatile.

Should Italian banks get into trouble as was the case in Ireland, they will bring down not just the EU economy, but Japan as well. For this reason, the French proposal for debt repayment extension that places greater interest payments on Greece and delays the problem for the future is crucial as far as EU is concerned, but it is nevertheless 'band aid' therapy as far as Standard and Poor's and rating agencies see it.

Is Greece facing default by any other name? Absolutely. One reason is that about a third of labor force works for the public sector and the economy is dependent on government spending that must be slashed sharply for the duration. Unemployment is officially at 17%, and will rise above 20% to 25% by year's end; that is, Great Depression levels. As the Greek economy continues to deteriorate and social upheaval increases, the banking system will show greater strains.

Given that EU banks hold equity capital at 3% of assets as compared with 4.5% in the US, liquidity would dry up for the entire banking system if at the same time Italian banks continue to show weaknesses as do those of Spain, Portugal, and Ireland. The only solution would be writing down the debt not just for Greece, but all debtor nations that would be unable to meet service obligations. The private sector would be seriously damaged and a downgrade of EU's banks would be inevitable.

Rating agencies have already warned BNP Paribas, Societe Generale and Credit Agricole, which hold a combined $65 billion in public and private Greek debt. The euro would lose a percentage of its value, thereby dragging the world economy into a double-dip recession that would more painful and more difficult to manage by debt-ridden governments than the recession that started in 2008. Under such a scenario, the EU integration model would collapse, there would be social upheaval, political polarization, and extreme instability that would further cause economic uncertainty.

One reason that the US has been pressuring Germany to prevent Greek default and to have all of the EU speak with one voice is because the collapse of the EU economy would mean a global recession that would send the US public debt to levels that could mean temporary suspension of debt payments - in effect default. The real problem, therefore, is that the US public debt is so out of control that lack of financial and economic steadiness in the EU would spell disaster for the US.

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