By Edward Harrison of Credit Writedowns
The Wall Street Journal is reporting that a plan to bail out Greece to the tune of $41 billion is now being formulated by Germany and France. It might seem as if a bailout is inevitable and that the terms of such a bailout are the only things now being negotiated between EU members. However, even within this account, German Chancellor spokesman Ulrich Wilhelm has denied that such a plan even exists. Clearly, then, there is still a lot of uncertainty about the situation in Greece – and whether they will receive a bailout and on what terms.
This post will update you on the latest events. But it should also give you a perspective on the historical reasons for the political posturing we are witnessing.
The Euro’s beginnings
The story began in March 1979, more than thirty years ago – before Greece was a member of the EU. This was when the ECU (European Currency Unit), the precursor to the Euro, came into being. The currency volatility which followed the break down in the Bretton Woods fixed exchange rate system in 1973 was a shock to policy makers and seen as a major source of economic instability during the 1970s. The goal in Europe was to create a European Exchange Rate Mechanism (ERM) which minimized currency volatility and set the stage for monetary union by fixing a maximum 2.25% range for currency fluctuation. But this also required a degree of economic harmonisation between countries on fiscal and monetary policy.
Unfortunately, the harmonisation was not forthcoming. Italy, in particular, was seen as politically unstable, with thirty different governments in the post-war First Republic from 1946-1994 and another eight since then. This meant that Italy often operated with a large fiscal deficit. It had high rates of inflation and a weak currency. Therefore, during the ERM days, its currency band was set at 6%.
Greece, Spain and Portugal ended dictatorships in 1974 and 1975 and 1976 respectively, paving their way for entry into the European Union in the 1980s. However, they too had fiscal, currency and inflation problems. So when the Euro’s terms were set in 1992 in the Maastricht Treaty, the Germans, in particular, were adamant about inserting the Stability and Growth Pact.
The Germans, who had seen their currency destroyed by Hyperinflation in the 1920s and the Nazis in the 1940s, were keen to ensure a strong currency. The Deutsche Mark had been a strong currency and this strength was seen as a major source of the German economic miracle which brought the country back from collapse after World War II. So, at the time of the Maastricht Treaty, the Germans wanted more European integration to keep the tensions which had led to two devastating wars in the 20th century at bay. But they also wanted to prevent free riders (like Portugal, Italy, Greece and Spain) from watering down the Euro with an inflationary economic policy and making it a weak currency.
The mechanism eventually chosen to stop free riders was the Stability and Growth Pact (SGP). This provision set strict limits on fiscal policy, namely an annual budget deficit of no greater than 3% and a debt-to-GDP ratio either of no greater than 60% or declining toward that mark.
Shenanigans to dodge the SGP
In the lead-up to the Euro’s creation, Theo Waigel, then the German finance minister and a leading Bavarian CSU politician, pushed for the SGP. But, many felt it was too restrictive and that enforcement was unworkable. Former EU and Italian head Romano Prodi called it “stupid.”
In fact, from the word go, countries were ‘cheating’ to gain admission into the Eurozone. Italy certainly was – and now we know Greece was as well. I wouldn’t be surprised if similar stories surfaced in Spain, Belgium, or Portugal. And eventually even France and Germany breached the 3% hurdle. When former German Chancellor Gerhard Schroeder’s government missed the 3% hurdle, he too called for scrapping the SGP. Hard money types like Ottmar Issing, the chief economist at the ECB, dismissed these calls out of hand.
Hardliners vs. Pollyannas?
It is these same hard money types who want Greece to dangle in the wind. Issing, now retired from the ECB wrote the following in the Financial Times two weeks ago:
To bail out Greece or not? The question is grabbing headlines daily. Supporters of a bail-out argue that if Greece collapses, others would follow. Financial markets have already identified the next candidates. As such, European economic and monetary union is at risk. Only financial aid and “solidarity” with highly indebted members can rescue the euro.
It is certainly true that this is a decisive moment for Emu – but for the opposite reason. Greece will continue to receive support from several European Union funds. But financial aid from other EU countries or institutions that amounted, directly or indirectly, to a bail-out would violate EU treaties and undermine the foundations of Emu. Such principles do not allow for compromise. Once Greece was helped, the dam would be broken. A bail-out for the country that broke the rules would make it impossible to deny aid to others.
–Europe cannot afford to rescue Greece, Otmar Issing, FT.com
Translation: Don’t bail out Greece. It is forbidden and invites others to ask for the same unwarranted hand out.
All this despite Germany’s breaking the 3% hurdle yet again. But, Issing is not the only one saying this. The Dutch joined the Germans in rejecting bailout of Greece weeks ago. Dutch premier Bos was quoted in the Dutch finance daily NRC Handelsblad as wanting the IMF involved (Dutch-language article here). The Irish and Swedish have joined the chorus of countries seeking austerity for the Greeks, with the Swedish premier also mentioning the IMF.
What you have is the countries with former ‘hard’ currencies balking at a bailout and wanting draconian terms for Greece if one is forthcoming. They are met by the former ‘soft’ currency countries pushing for a bailout. The press from this morning shows you how political this debate is based on the slant of the headlines. In Ireland it’s: EU demands Greece acts on debt ahead of bailout package. But, in Spain, it’s “Zapatero proposes a joint rescue for Greece (Zapatero propone un rescate común para Grecia).”
Conflicting reports
Meanwhile in North America, the National Post says: “EU tells Greece to do more on budget, markets improve” which is a very different spin than the Wall Street Journal’s “Greece Bailout Plan Takes Shape.”
All of this is spin and speculation. The fact is no one knows where this is headed. Two weeks ago after the EU issued it’s first statement of support for Greece, I said:
…the approach seems to be long on psychological and political support and short on specifics or financial aid. In theory, there will be loans in exchange for austerity. Details are to come. But the euro has sold off on the news. Moreover, as this is a debt crisis, not just a crisis of confidence, I don’t think ”psychological and political support” is going to cut it.
And I think the politicians get this. Therefore, they are working to do something more concrete. My understanding is that they are looking to offer a support package i.e. a contingency plan under which a bailout via loan guarantees or Greek debt purchases kicks in only if necessary. This kind of ”psychological and political support” is more concrete and more credible. The EU is hoping that the pressure on Greece will subside if they commit categorically to a contingent bailout.
Other possibilities include an EU-led bailout with IMF ‘technical advisory assistance’ in exchange for fiscal austerity from the Greeks. This is what I have proposed. But, my proposal understands that fiscal tightening doesn’t happen in a vacuum. There are consequences for the trade and private sector because the financial sectors must balance. A lot of people, including the American President, don’t seem to understand this (see my post “Barack Obama: “if we keep on adding to the debt… that could actually lead to a double-dip” The problem with fiscal austerity is that it reduces the government sector’s deficit which must be offset by an equivalent decrease in the combined private and trade sectors’ surplus. Given the fixed exchange rate, all of the burden falls on the private sector for this adjustment Translation: if the government cuts its deficit by 10% of GDP in a fixed exchange rate system as Greece must do to get into SGP compliance, it automatically means the private sector must spend 10% more of GDP. This likely means piling on private sector debt in a country awash in debt.
However, in my view, it is wishful thinking to think more than that is coming given the resistance to a bailout in Germany, Sweden, the Netherlands, and Ireland I have detailed here and previously. But given the focus on the fiscal side of things without considering the context for the private and trade sectors, we are headed to a poor outcome. I hope that helps put this debate in context.
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I would love to believe that finally someone will draw a line on moral hazard during this crisis. If history is any guide, we should not hold our breath. Expect the Germans to fold, and for the Greeks to fully play their hand to this end. I know Lehman fell, but I sense the lesson learned from Lehman was that they were too big to fail.
Angela Merkel publicly DENIED that Germany will EVER bailout Greece FOR THE 2nd TIME:
http://www.businessinsider.com/angela-merkel-denies-greek-bailout-2010-2
Yet I continue to see the American mainstream media claim that a Greece bailout is being considered time & time again! Are the pump monkeys hard at work???
Check out this article written by Economist Komal Sri-Kumar
https://www.tcw.com/News_and_Commentary/Market_Commentary/Insights/02-16-10_Greek_Bailout.aspx
“One of mythology’s most vivid lessons in unintended consequences is the story of the Trojan Horse – the sneak attack that enabled Greek soldiers to secretly enter and destroy the ancient city of Troy. I fear the Eurozone powers may be reenacting this story in their efforts to rescue Greece from a debt crisis, only this time, they themselves are building the Trojan Horse that will soon haunt them. Advice: beware the bailout of Greece, it brings unintended consequences that could weaken the entire Eurozone.”
What were the unintened consequences of the Trojan Horse?
And what is the Trojan Horse Eurozone poweres may be reenacting – the bailout itself or the rumor of the bailout? The Trojan Horse is the bailout itself if their (the Eurozone powers’) efforts are to destroy Greece surreptiously, instead of ‘to rescue Greece from a debt crisis’ as the author wrote.
You must be American and not European. Europeans know full well that NO-ONE except Greece wants the bailout. The German Government doesn’t want it and this is fully supported by German citizens. They would happily allow the Euro to depreciate significantly. This would help their Exporters. Only America and “The Powers That Be” want a bailout for Greece, but it’s not going to happen. Angela Merkel herself confirmed that: “We have a (European) treaty under which there is NO POSSIBILITY of paying to bail out states in difficulty.”
It’s only the US mainstream media which continues to propogate LIES from unconfirmed “sources” to stop the Markets from Deleveraging further. This will turn out to be a turning point in the Markets when American mainstream media finally acknowledges the reality of this situation.
If they bailout Greece, then why not Portugal, too? And then Spain? And who’s gonna rescue Japan/UK when their SHTF? These excessive Debt problems are MASSIVE and they’re not going away. You can’t sober up a drunk by giving them another bottle of whiskey.
Small correction: the order of the end of dictatorships in the 3 countries is Portugal (April 1974), Greece (November 1974) and Spain (November 1975).
Thanks for the correction on dates. Isabel, I am considering the 1976 constitution as the date for the end of dictatorship in Portugal. Legitimately, I should have used 1978 for Spain then. So, really, it is 1974 for Greece 1976 for Portugal and 1978 for Spain.
In that case you should say 1975 for Greece ;-)
The German manufacturing sector in particular and the export sector in general are pressuring the their government for some currency relief, 10% would suit very nicely. Similarly in France and other manufacturing powerhouses such as Ireland, Italy and Austria the presure is on to depreciate the Euro vs the US$ and the Yen. The posturing surrounding Greece’s bailout must be viewed through the Euro depreciation lens. So, what now, expect uncertainty, uncertainty and more uncertainty expressed by Germany and France and the supporting cast of Euro depreciators. Will Greece be bailed out? Yes it will, but not generously , the uncertainty pot must be kept boiling. Those Europeans think strategically and three steps ahead.
Portugal had a coup-detat in !974 but first elections for all in 1975. In 1976 the portuguese constitution is aproved by new MPs and democracy is oficial since then. The first general elections took place in 25 April 1975.
Paulo Monteiro
Greece is in desperate need of a bailout now and there’s no way that the European Union is going to delay it much longer. The question is, what is the best way to trade in the stock market with international events showing such volatility?
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if any type of bailout or guarantee is effected,then watch for fall of the Merkel government .If i were a German why would I bailout a country in which wages rose almost 11% last year and mine were flat.I find it amusing that only 1 month ago Mr Obama called for a huge increase in exports.if the dollar rallies any more exports might actually dercrease
I completely agree with your post: What better way to depreciate the Euro without having to face political discussion? The Euro is devaluing to levels not seen for about a year, a rate that can nicely be locked in by exporting companies through the use of derivatives.
Strategically it is a win-win all around. The greek government has the right environment of fear to push through austerity measures, french, german, dutch, italian,… manufacturers are able to lock in advantageous exchange rates, in real terms, the whole issue is a storm in a tea cup.
Whats not to like about it?
The additional benefit is, that this is a great opportunity to break the back of the speculators. The current policy of essentially giving a statement of support, without announcing any concrete steps is brilliant. It keeps the uncertainty alive. The speculators are well aware of the fact, that either France or Germany could rescue Greece if they chose to do so, without causing as much as a blip in terms of their solvency. Therefore the real question is: Who can afford to play for time? A devaluing Euro, external pressure for fiscal constraint, sounds like a real net positive for the Euro zone(No need to introduce tarifs/sanctions on chinese exports,…). But what is the situation for the hedge funds and banks involved? Can they really afford to loose 3.5-4% p.a. on a 1:20-1:60 leverage?
I don´t see any reason, why Europe can´t let this situation drag on for a year or two. Even if a greek bond auction should fail, there are enough government owned banks around to buy up any unsold debt. Let´s not kid ourselves, the current refinancing needs of Greece(~€60bn€) are peanuts Germany alone spent/guaranteed roughly €500bn in order to not see the banking sector fail. How likely is it that the whole currency area will be let go of. It is very easy for french and german government controlled banks to buy up surplus greek bonds(not sold in auction) “for commercial reasons” whilst the governments still maintain the current stand of not being able to support a bailout for political reasons.
This is a game of chicken. Quite frankly I don´t see European governments blinking first!
Speculative attacks are great, if you succeed within a matter of days, weeks, or at the very most months, otherwise they can get really expensive. European governments can essentially wait out the situation for years, I wonder how long it would take for some of the financiers of the companies currently speculating against Greece to get really nervous, given CDS cost and given leverage.
Furthermore, as is currently happening, the speculation going on is against the ones making the rules and enforcing them. Merkel has quite clearly stated, that she will not see any speculators profiting from the current situation. A sentiment, probably one of the few, that is shared by European countries currently in trouble, as well as those expected to potentially bail them out.
An interesting topic for analysis as well as a post may very well be, how long a speculative attack can actually be kept up without results, given a CDS premium and depending on the level of leverage.
The most important thing to keep in mind about our current crisis is that it is an energy crisis, not a finance or debt crisis.
Debt mediates the energy availability shortfall, imposing an affordability rationing regime. The outcome is gas lines are replaced by business failures.
If there is no bailout for Greece (and the rest) there will be deflationary collapse which will end the euro. Austerity means the same thing. A bailout buys time … to implement energy conservation measures that can staunch the flow of wealth from the Eurozone toward the Middle East and elsewhere.
Austerity fails in an energy crisis because there is no rebound in growth at lower price levels because there is no production – it is constrained by lack of energy as is the situation right now.
A reason the euro was created because the European nations did not want to buy paper dollars first in order to buy crude oil. Now … because of a super- hard dollar and its peg to crude, Eurolandia has to buy dollars first in order to buy crude. The euro has no reason to exist …
Eurolandia not only has a wealth deficit but also a structural energy deficit. It produces nothing of value to trade for the oil it wastefully consumes … only more items (BMWs, Mercedes, etc.) that amplify consumption and make things worse!
In addition, nothing will improve until the US goes ‘off oil’ and breaks the crude/dollar fetter. By nothing, I mean accelerating credit imbalances in Europe, UK, USA and Japan and bubbles in China and the developing nations. Dollars will vanish from circulation and with these dollars will vanish energy availability. The increasingly scarce and valuable dollars will mean the producers will take nothing else leading to a rout in other currencies.
This is the terrible and devastating vicious currency cycle that is already starting to manifest itself … in Europe.
Look at the ongoing rout in sterling; UK having pissed away its oil patrimony on stupid freeways and wasteful consumption.
China is desperate to decouple from the now diamond- hard dollar because their yuan peg makes it rock- like, as well. Yet, the yuan does not trade – China’s own currency is less useful to it than its dollar reserves it was sneering at just months ago! The outcome in China a printing deluge of yuan to escape dollar- derived deflation.
Finally, the high- oil- price- stranding- the world’s economy is manifest currently in the oil refinery sector. Oil prices are so high that refinery margins are collapsing. The same thing has been happening in other businesses in the US and the world beginning in 2004. I hate to rub it in, but Peak Oil took place in 2998, when crude could be had in any quantity for less then $12 a barrel. Availability has steadily contracted, crippling the margins of any business that processes energy in any form … that is, just about all modern businesses.
When the refinery sector is stranded by high crude prices the world economic charade is ended.
The only solution is conservation and by this a reduction in fuel use on the order of 50% which is required to break the dollar peg as well as put the producer cartel out of business. The 50% could probably achieved in the US by simply junking all SUV’s.
The alternative is an onrunning collapse of all finance as well as classic energy supply shortfalls as refineries close.
Yes, but. What happens when the problem is insolvency?
My hunch is the correct solution is to monetize debt, very cautiously, until inflation lets the out of balance sectors (here, primarily wages) catch up with already inflated asset prices. Traditionally, central banks make haste to sterilize new debt, by offsetting it with long term bonds. Digging deeper into the debt hole.
But why not simply print small, calibrated amounts of cash in a situation like this, and divvy it up, say, with a negative income tax, perhaps with a cap at say 200% of median wage. Enough of that money would be spent to prime the pump. Well, perhaps priming the pump isn’t an apt metaphor here, unless the pump got dropped 6 miles deep in the Pacific, or something, as there might be a lot of priming to do to get that damn thing back to the surface, before traditional concerns about printing money come into play (and before the fed’s trational toolset is functional).
But this issue, I think, is that we’ve run the economy with a wink and a nod that central bankers would keep the money pump running in favor of those especially favored, so a lot of things were done that didn’t make economic sense. And digging out of that sort of mess by further voiding economic sense, I’m just not sure that is the best long term way to make the economy operative again.
I think we have to be pragmatic in the approach to this Euro zone sovereign debt crisis. That suggests a more homogeneous “unicredit” type of bond market which means that the issuance of EU bonds is necessary. If the Euro is in trouble you need more Euro integration not less.
It’s easy: if you just apply a financial transaction tax at EU level (US will come later on…) you get immediately some 100-200 billions Euro. With this money you can set up a European monetary Fund, arrange for Greece bailout and/or even fund the EU budget as its single own resource.
Technically you could also start the common issuance of an EU bond without backing of a financial transaction tax as revenue. In this case we should arrange for cross-guarantees and appropriate sharing of interest rates to be paid among EU Member States. This would not only significantly reduce the cost of financing of PIGS debt (in the case of Greece the spread is more than 4% over German bond thus the savings from a common EU issuance are quite big and more than any fiscal measures), while creating a EU bond market, but it would replace any International Monetary Fund role and/or conditional loans.
I keep seeing the Netherlands popping up in bailout articles like this as being one of the “creditor” nations for a bailout.
Just to point this out. The Dutch government fell last week. So the current government is a demissionary cabinet, which as by the constitution is NOT allowed to make major decisions. And shipping out millions of euro to bail out another EU nation definitely counts as a major one.
If you see a claim that the Netherlands is involved in some kind of bailout for Greece it’s a lie, period. They aren’t allowed to do such a thing even if they wanted to (which I doubt).
Basically, for the next half year until the government is reformed, don’t count on any bailout money from the Netherlands.
Otmar Issing is “International Advisor to Goldman Sachs Int.” since 2006. See his CV on the university of Frankfurt web page:
http://www.ifk-cfs.de/index.php?id=120&L=0
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