Greece will not make it?

German economists seem to believe that Greece's burden of public debt will not be sustainable and fears of a Grexit are bound to resurface. To these bad news, they also add the sad forecast of a mere 0.8% growth in Germany during 2012 instead of the original 2%. On the bright side, unemployment in the EU27 and EA17 has not risen during August.

Source: Eurostat

Although the whole of Europe indicates a stabilizing tendency in unemployment, individual countries are not doing so well. In Greece unemployment has risen by 7% over one year (June 2011 and June 2012), in Cyprus 3.7% (and they have not even officially signed the bail-out treaty), in Portugal 3.2% and in Spain 3.2% (to an astonishing 25.1%!). Greece and Spain were also declared champions of the youth unemployment with the percentage reaching 55.4% and 52.9% respectively.

Well, I guess when a quarter of your population is not employed and more than a half of your youths are unemployed things are going to get a lot worse. For this, we can blame the austerity measures imposed by Mrs Merkel. I do not know what they had in mind when she and the group of accountants and economists which formed the Troika decided that slashing expenses would be good to an economy. I guess not much. When GDP goes down, debt as a percentage of GDP goes up, even though it may not increase in absolute terms. Now the German economists are afraid for a situation which they have created themselves: Greece is going down and it is taking everyone with it. Even if Greece collapses with not many consequences (which I seriously doubt), Spain will not be so kind.

Over the second quarter EU27 and EU17 GDP have also been reduced by 0.1% and 0.2% respectively. This means that if the next statistics indicate that GDP growth is again negative, Europe will have officially entered recession. Thus, a problem which was (erroneously) considered to be an issue of the EU-periphery has taken an EU-wide dimension. This also makes me eager to see whether EU public debt has increased over the second and third quarters, an analysis which has yet to be published. 

Source: Wikimedia Commons

What the German economists are now promoting is "orderly bankruptcy proceedings for member-states". Thanks guys, I guess you are very fond of European integration. This solution is of the kind "let them bankrupt I do not care". No form of solidarity in their statements whatsoever. I do not know if German economists ever think about the consequences (they obviously have not thought about them when austerity measures were pushed through in Greece; and are going to be implemented in Cyprus as well) however, if Greece goes bankrupt the effects will be harsh on Germany. Especially since the next one to go will be Spain. 

Integration and not harsh measures are needed for us to steer clear of the crisis. Yet, what is being promoted are measures which do not assist in solidarity amongst nations. I guess this is the only time when politicians should be making more decisions than economists. At least they have the to worry about being re-elected. To whom are economists accountable for bad advice and forecasts? Nobody.

A week to know about Greek Bankruptcy

Greek Prime Minister Antonis Samaras has a planned visit to Germany next week, during which he will meet with Angela Merkel to discuss a two-year extension to his country's austerity measures. 

On one hand Samaras's plea makes sense: The austerity measures taken so far have paralyzed the country and made it go through one of the worst recessions in history. Next year is expected to be better for the Greeks as a recent IMF forecast expects GDP to be stable for the whole of 2013. (more on Greece's Progress here). It is more than reasonable to assume that both his popularity and his country's GDP will face a sharp drop if any more austerity measures are rapidly implemented. Even now, due to lack of money, Greece has to resolve to creative emergency loans in order to avoid default.

On the other hand Merkel's hard opposition makes sense as well: If the leader of one of the strongest economies in the EU accepts Samaras's terms then what would stop the Greek Prime Minister from asking for longer and longer time frames at the end of the two-year period? Let us not forget that the Greeks are to blame for their mishaps, although they may be suffering more than enough for them. €4 billion in savings from austerity measures are still missing, a prerequisite for the additional €31.5 billion the IMF and EU will disburse under the second bail-out package.

It seems like the two have reached an impasse: None of them is willing to fully accept what the other has to propose. The situation might look like a Gordian knot, however, like Alexander the Great (or Solomon if you prefer) I would suggest something simple: Compromise at a one-year extension of austerity measures, in order for the Greeks to have a smoother adjustment to them. In essence this would ease the consequences of hard austerity measures as their effect would be smoothed out over a year. 

Nevertheless, for the Germans and other Greek creditors to be sure that the reforms will take place, and their hard-earned money are safe, Samaras will have to formally present the reforms to be undertaken on a given date. On that date, (maybe in late 2012 or early 2013) the reforms would be presented to the public in a press conference, and the exact date of their implementation will then be set. 

In a compromise like the one described above, Greece's creditors would have an easy way of checking whether the Greeks have kept their word, while at the same time allowing the country to ease the pressure of rapid austerity measures. This would allow markets to believe that the odds of a Grexit scenario are declining. 

However, even if they disagree on everything, the Greeks should still receive the €31.5 billion package. Failure to do that would bring the EU down until the end of the year.

The Effects of a Euro Collapse

Some believe that the destruction of the Eurozone, and as a consequence the collapse of the common currency, is eminent. Many actually look at this favorably as they believe that such a result would be beneficial to the world. I have read articles stating "why doesn't the Euro collapse to get over with this situation? We will deal with the consequences and then be better off". The problem is no one seems to understand what these consequences are. 

The following is an excerpt from a Financial Times article in 2011 (article can be found here):

"A euro area breakup, even a partial one involving the exit of one or more fiscally and competitively weak countries, would be chaotic. A full or comprehensive break-up, with the euro area splintering into a Greater Deutschmark zone and about 10 national currencies would create pandemonium. It would not be a planned, orderly, gradual unwinding of existing political, economic and legal commitments. Exit, partial or full, would likely be precipitated by disorderly sovereign defaults in the fiscally and competitively weak member states, whose currencies would weaken dramatically and whose banks would fail. If Spain and Italy were to exit, there would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression."

Does this sound bad enough? The article states that a Greek exit could be manageable. It could be, only if the ECB decides to bail-out the EU countries which would be affected by that exit (That would be hmm... almost every country in the EU, even Germany). If the ECB decides that it would help the countries which would face disaster after a Grexit then why not help Greece directly and avoid such an outcome? The outcome of an Italian exit would be even worse given that it is the 8th largest economy in the world. You may only imagine what would happen if Germany were to exit.

The aftermath of an exit would occur not only to the Union but to the exiting country as well. For example, a Greek exit would mean that prices and wages in the country would fall rapidly, gaining a short-run competitive advantage which would be lost after inflationary powers settle on the country. As a result, the country would be poor, uncompetitive and with the additional disadvantage that no one would dare lend it because it that had just exited the EU. If Germany exits then the new German currency would suffer such an up-rise which would make all German products uncompetitive, leading the now booming German exports to a downward spiral.

In another article, a euro collapse is called as the "mother of all financial disaster". Robert Zoellick, the former president of the World Bank has stated that Europe may have a Lehman moment. (Just like the Lehman Brothers collapse in 2008, which triggered the worst recession in the world since the 1930's).

The worst part of all is that most of the consequences which may occur under a Euro collapse are still unknown. Germany is thought to be the state with the most sound economy in the EU now. However, German investors hold 550bn euros of sovereign bonds outside of Germany. What would happen if the euro collapsed? Most likely they would lose it all and the German government would have to bail them out. One may only imagine how many EU bonds are in the hands of non-European banks and other investors.

My simple conclusion agrees with this LSE article: It is better to do everything to save the euro than to let it fall apart.

Greek Bankruptcy can help the EU?

In an article in Der Spiegel yesterday, Stefan Kaisser states that a Greek bankruptcy, although costly, is the best way to resolve the current situation in the EU. Current plans for Greece, as stated in the article, are the following: The Greek government is supposed to borrow the money it needs from the ailing Greek banks. In return, the banks receive sovereign bonds that they can, in turn, provide as securities for new loans from Greece's central bank. In this way, Greece's central bank is financing the Greek state in what is really just a kind of shell game that gets riskier the longer it is played. This arrangement reminds me of leveraging (the idea that instead of banks lending a proportion of what they have as deposits, they end up lending maybe 50 times more, a policy most large banking institutions adhere to) and is not one which leads to stability.

However, I do not believe that bankrupting Greece would solve anything.

On one hand, the consequences are unknown. Even Germany, with its strong economy, has to to prepare itself for a major economic catastrophe. And whilst the Germans may have the funds to bail-out their banks, most EU countries do not. So what would happen is that more countries will ask for help from the EFSF/ESM. What happens if these countries also face fiscal difficulties which would be a direct outcome of the Greek bankruptcy (and in essence German EU politics)? Let them go broke too?

The other big question is what happens after the bankruptcy. Does Greece go back to drachma or does it stay in the common currency? If Greece exits the euro then what is the message sent to other countries: bad fiscal planning and you are out of the euro? Will Greece be allowed to return after some years have passed? For conversation's sake let's assume that Greece does not do the stupid thing and remains in the Euro (although I highly doubt it, since anti-european movements will increase in popularity after a bankruptcy). What happens next? Who is going to lend a country which received enormous amounts of help from the ECB and the IMF and still managed to default? Guess: the ECB and the IMF again.

Although the Greeks should - and do - receive the blame for the situation in their country, Merkel's austerity remedies seem to have lost their charm since they have not been able to reverse the current situation. The Greeks themselves cannot do anything more than austerity measures and stimulus from the ECB anymore. What should be done is a change in German and EU politics: The ECB should be allowed to move directly and INDEPENDENTLY in order to buy Greek bonds or any other sovereign bonds deems proper, to restore order in the markets, just as a normal central bank would do.

Let us not forget that it is the Greek haircut we have to condemn for the current situation in the EU; and this is a direct consequence of political decisions (mostly German) which were based on flawed arguments. I do not think that it is too late for an ECB intervention which would end problems in the South in the next years and restore confidence in the markets.

As for the "spiral of threats and rescue actions" Berlin and Brussels got themselves into they only have to accuse themselves. It is never too late for admitting a mistake and moving on to correct it.