Friday, January 29, 2010

The Final Countdown: Greek Sovereign Default

The aptly named band Europe brought us the epic music video and song "The Final Countdown" about 20 years too early (I mean, who cares about the countdown to the end of communism - let's talk about the PIIGS sovereign default).

As I read all these articles about Greece's impending doom, it's hard not to hear in the back of my head the implied complaint, "why won't they just lend us the money for free? This doesn't make any sense. Just lend us the money for free!"

[emphasis added and comments in brackets]
Europe Weighs Possibility of Debt Default in Greece
New York Times

European leaders are quietly considering whether to come to the aid of their troubled neighbor Greece amid fears that the nation might default on its debts and unleash another round of financial crisis.

Only a month after Dubai was rescued by its neighboring emirate Abu Dhabi, Germany, France and other European powers are discussing whether Greece might need a bailout too.

After a decade of debt-fueled profligacy, Greece is confronting what amounts to a run on the bank. And, despite repeated assurances from Athens, the nation’s strained finances have put already jittery financial markets on edge. On Thursday, the worries stretched all the way to Wall Street, where the stock market sank 1.1 percent.

Some economists worry that Greece’s troubles could have deep and lasting repercussions for Europe. The crisis poses complex challenges for the euro, which Greece adopted in 2001. The currency sank to a six-month low against the dollar and yen on Thursday.[ironically, TILB thinks letting Greece go could be an incredibly strong event for the euro]

“Greece failing is not an option, and lots of people think that we will have to intervene at some stage,” said one European finance official, who was not permitted to speak publicly on the matter. “It doesn’t have to happen, and we hope it won’t, but it would be better than seeing a default.”


But doubts have intensified over the credibility of the drastic austerity measures put forward to try to get Greece’s budget under control, in spite of concerted efforts by the Greek government to calm the markets.

Investors worry that the crisis in Greece could touch off a domino effect across Southern Europe. Many are fleeing bond markets in Portugal, Spain and Italy out of concern the troubles might spread. [TILB - Collectively known as the PIIGS when Ireland is included]

The market’s judgment has been swift and brutal. On Thursday, the difference between the interest rates on Greek and German bonds — a measure of the risk investors perceive in the Greek debt — rose to nearly four full percentage points, its highest level since the euro was adopted.

Officials in Athens, Frankfurt and Brussels remained adamant that Greece was not at risk of being forced to abandon the euro. [TILB - of course not. Could you imagine if they said, "hey, we're thinking of going back to the Drachma so that we can print our way out of this debacle?" That would be amazing.]

As a condition of any aid package, the Greek government led by Mr. Papandreou would be asked to provide a more detailed program to bring the country’s deficit — currently equal to 12.7 percent of gross domestic product — under control. European Union rules call for a maximum of 3 percent. Officials insist that any bailout must not put into doubt the credibility of the euro.

Another condition of any aid would be further guarantees over the reliability of Greece’s economic data. Last year the newly elected government in Athens announced a sharp upward revision of its deficit figures, which have since been exposed as seriously flawed.

Next week, the European Commission is expected to propose greater powers for the European statistical agency, Eurostat, to audit the accounts of national governments. [TILB - watch Czech president Vaclav Klaus give this interview where he presciently assesses the fact that the EU and the Euro are forfeitures of sovereignity and freedom, then watch the slow leech of powers from the states to the centralized United States of Europe]

The latest moves reflect a continuing skepticism among euro-zone members over the practicality of the plans put forward so far by the Greek government. Athens wants to reduce the deficit to 3 percent of G.D.P. by 2012, an objective described as unrealistic by one European diplomat, also speaking on condition of anonymity. These plans are also to be assessed by the commission next week.

Greece’s budget deficit is four times the E.U. limit, while the country’s debt amounts to 113 percent of G.D.P. But officials insist that, because Greece is not one of the euro zone’s larger economies, the problems created by its grim public finances can be absorbed. The Greek economy represents about 2.5 percent of the euro area’s G.D.P. [TILB - Japan is over 200% sovereign debt to GDP and the US is a bit over 80%. Carmen Reinhardt and Kenneth Rogoff show that 90% is the threshold past which few survive, as well as 60% externally financed debt to GDP - this latter point has been Japan's saving grace, though that is likely over]


For Greece’s neighbors, there is the possibility of a domino effect, with investors subsequently moving on to test the resilience of another heavily indebted member of the euro area — possibly Italy, whose debt is also 113 percent of its gross domestic product.


One option, deemed unlikely, would be issuing a sovereign bond for the entire 16-nation euro area. That would probably require complex legal changes among members. [TILB - see prior Vaclav Klaus reference]


On Monday, Greece paid a hefty 6.22 percent rate to borrow money in the bond market, underscoring investors’ concern. [TILB - and it's much more expensive for them already, just five days later. If memory serves us well, they have a number of huge maturities in April/May that will be challenging to finance affordably without German backstop...]

In an interview this week, the Greek finance minister, George Papaconstantinou, acknowledged that the high rates were punitive but asked that investors keep faith. Greece needs to raise at least 53 billion euros this year, much of it this spring.
People think this is news?

As we've been saying for a year, just wait until Japan blows. It's situation is nearly twice as bad as Greece's. Despite having 40% of the U.S.'s GDP, it has as much debt. If its blended cost of funding goes up from 1.5% to a bit over 3%, 100% of its tax revenue will be absorbed by interest expense. We're talking about the second largest economy in the world and it literally has no other options than massively debasing its currency or defualting on its debt (or, more likely, both). That's what they get for following Bernanke's wicked advice.

The sooner Japan blows, the better for the U.S. - I suspect our only hope of not suffering the same fate is to witness Japan's meltdown after having followed a similar prescription.

And as to Europe, just wait until Greece's implosion lights up Italy, which is a very large economy. That is the real worry the EU is facing: do we let Italy go?

Which brings us full circle, to The Final Countdown...