Thursday, 16 February 2012

Greece and the Euro-crisis: the End-Game or the Beginning of the End?

In an earlier blog on the issue  I concluded that brinkmanship will take us to the edge but that Greece will get the next bail out of €130bn and in turn allow it to meet the March 20th repayment of €14.4bn. This remains my baseline scenario.

Even if the baseline holds, the Sovereign Crisis will by no means be over. The resolution of Greece's external debt overhang will still not be complete and the 120% of GDP target by 2020 that has become a gospel-esque benchmark will require further reduction, particularly against a further deterioration of the economy.

Secondly, as also concluded in the earlier blog, the Crisis is pan-European in nature and as such whatever happens to Greece will affect how economic agents - both debtors, creditors and market participants - assess the probability of replication to other soverigns facing the music.

What has changed in the last two weeks is a growing schism in rhetoric from both sides of the de facto Transfer Union: growing angst among the donor countries whether they are about to throw in good money after bad and whether Greece will be able to comply with the already onerous conditions being imposed. And from the Greeks vociferous complaints about German-fostered austerity and what many there see as de facto colonialism. Elections in Greece are due in April and the polls show an erosion of the centre and toward the extremes on either flank, which raises political risk beyond April.

There is also a gung-ho attitude emerging from the donor north that is now openly airing the possibility of a Greek default and exit from the Euro. This is supposedly premised on the robustness of the new defence lines and safeguards via the EFSF and the ESM.

Sand-castles and Maginot Lines of defence more only hopes that this is gung-ho talk as part of the back-and-forth fine-tuning of conditionalities under the aegis of the Troika (EU, IMF and ECB).

On the other hand we have increasing market chatter of a likely Greek default - in part fed by the statements from Finance Ministry officials in the donor Euro-north - and the likes of John Paulson (Hedge Funder) are forecasting and betting on the total break-up of the Euro.

Put it together and we have the continuing uncertainty and volatility in the markets and in policy and looking ahead for the rest of 2012.

Why the (messy) status-quo will remain and the Euro won't break up (at least in the near term):

  1. The markets - particularly outside the Continent - do not fully appreciate the European mindset that exists not only among the political elite but reflects a general consensus in society for the need of a European framework. The EU is the glue that emerged out of the last World War and has enormous groundswell of support. Its institutional structures will therefore continue to grind forward toward consensus and agreement - it is in the DNA of the EC - but also among the EU Member States.
  2. This in turn means that at an operational level the machinery to ensure process and procedure will continue to take its course and which tends to gravitate toward risk-neutral outcomes.
  3. The Franco-German axis will continue to set the agenda and neither wants Greece to collapse. Germany has, despite howls of Greek horror, put up massive amounts of capital but understandably wants surety that there will be value-for-money. However Merkel's vision is clearly focussed on imposing German-style fiscal rigour and an incremental approach to the crisis that is not everyone's flavour. A disorderly Greek exit which if followed to its logical conclusion to a collapse of the Eurozone, the return of the DM and it subsequent strengthening would not be in the German economic interest. French president Sarkozy on the other is an election mode and fighting to save his presidency - the last thing he needs is Greece bellying-up, an immediate impact on banks in France and a possible banking crisis and risk to re-election.
  4. Firewalls? Yes they exist but do we really want them tested? One lesson from the Banking Crisis has been that number-crunchers tend to always underestimate the true scale of woes and related costs. And the European banking scene  has not really undergone the reparation of balance sheets seen in the US. Remember the "dis-stress tests" by the EBA last year?
  5. Not assisting the Greeks is self-defeating as any exit from the Euro will lead to an even bigger economic shock and meltdown there - in the end Greece as an EU Member State will require massive aid flows from the rest of the EU (and which will suck in non Eurozoners like the UK), but its exit would be the canary in the mine that acts as a catalyst on expected attacks on other sovereigns in the Eurozone but also among dodgy CEEs outside the EU (Hungary, Serbia, Romania...), runs on banking systems, a deeper credit crunch and goodbye to fragile signs of growth in the EU and ultimately growth globally. And hit Eurozone Treasuries through the quasi-fiscal liabilities of their share of support to Greece via the ECB.
  6. It is in the interests of Greece to sign-off on any demands but the EU will need to start focussing on how to improve the growth prospects and bring a degree of genuine solidarity and ownership. 
  7. Supply side reforms will bring benefits in Greece (and in Italy) which in many ways is a transition economy in terms of institutional structures and inter-operability of IT systems in budget planning, execution and financial reporting that have been shown to provide fairly quick wins for the new EU Member States - but standards for which were not strictly applied to Greece during its accession to the EU in 1981 or indeed in terms of the rigour for the benchmarking when Greece submitted its request to join the Eurozone in 2000.
The doomsday scenario is how a disorderly Greek default would amplify pan-country risk and in turn deteriorate already fragile growth trajectories is worth painting out next time. 

Finally, and continuing with the doomsday scenario, were Greece to exit, then I would support the Paulson thesis that we could see a very quick and messy Euro-break up - and far faster than models project. We know when economic or political unions break they can do so very quickly when a point of  inflexion is reached - as anyone who recalls the domino effect of the collapse of the Iron curtain will recall.

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