In the eurozone periphery, after several years of eurocrisis, debt/GDP ratios are still rising and the periphery is subject to several deadly vicious cycles. Forced austerity worsens the economic crisis, increases joblessness and bankruptcies, thereby reducing the tax base and forcing yet more budget cuts.
The specter of high interest rates, economic crisis, increasing tax rates, and uncertainty over the health of banks and euro membership leads to an investors strike and capital flight and emigration of the best and the brightest, further worsening economic conditions.
This paralysis is most manifest in Greece. After several conditional aid packages and debt haircuts, the situation has only dramatically worsened. Large haircuts on Greek bondholders have already taken place, but not even that has stabilized the debt/GDP ratio, or brought that any nearer, let alone having led to any modicum of economic stability. The Greek economy is now in its sixth year of recession and this isn't going to end next year.
Most of the Greek debt is now in "official" hands, that is, in the hands of EU members, the IMF, and the ECB. It is clear for all that they will also have to swallow cuts, but for this to take place, politicians have to break promises, the ECB has to break the law, and the IMF has to do something rather unprecedented. None of this is easy, to put it mildly.
Recently, there was a new EU/IMF/ECB 'agreement' that won't fare any better. In fact, there is every chance it will rapidly unravel. It consists of a number of elements. IMF director Christine Lagarde sums it up:
The initiatives include Greek debt buybacks, return of Securities Market Programme (SMP) profits to Greece, reduction of Greek Loan Facility (GLF) interest rates, significant extension of GLF and European Financial Stability Facility (EFSF) maturities, and the deferral of EFSF interest rate payments.
It is supposed to lead to a debt/GDP ratio of 124% by 2020 and below 110% by 2022, but you should keep in mind that all these targets have been wildly off in the past. So, in terms of measures we have:
- Lower interest rates and extended maturities
- Providing Greece the ECB profits on Greek bonds
- Lend Greece 10 billion euro, enabling a debt buyback at a maximum of some 29 cents to the euro
First, interest rates were lowered and maturity extended on much of the Greek debt. In many northern eurozone countries, this is already a rather hard sell, as it means that the promised profits on lending Greece will not materialize. This was always more fiction than fact. Basically, we're lending Greece more in order for it to keep the appearance that it is servicing and paying of the debt.
Second, it could very well be that there won't be any ECB profits on Greek debt. Third, Greece is going to borrow another 10 billion euro to enable it to retire existing debt at a fraction of the face value. And here is the snag:
The International Monetary Fund will not disburse Greece's next bailout tranche until the country completes a voluntary buy back of its debt, an IMF spokesman said [Reuters]
If the IMF walks, Finland and the Netherlands withdraw from the agreement as well. And there is more. Who will actually sell the debt at a 70% discount? Most private Greek debt holders just want to hold to maturity, they've already been subjected to two haircuts. This makes the market for Greek debt rather thin, any buying in volume could raise prices substantially, which reduces the advantages of the scheme and enriches vulture funds.
Two thirds of the private holders of Greek debt are Greek banks (22 billion euro). These are certainly not going to sell because doing so forces them to realize losses on the debt, in which case they'll become insolvable and in need of a bail-out. In any case, the debt is used as collateral to secure funding from the ECB, as the banks have been plagued by losses and deposit flight.
In any case, this is going to become interesting fairly soon. Here is Mr. Rice, director of external relations in the IMF:
we welcome the announcement by the Greek authorities that they plan to start the buyback process next week and we look forward to its implementation. I think we should wait for that process to play out and then we will be taking stock.
We fear that this could easily unravel pretty soon. There is a simple and obvious solution, which will then force itself. The official creditors should take really substantial losses on Greek debt.
The simple truth is that as long as Greece's economy is moribund and its debt/GDP trajectory spiraling out of control, nobody is going to invest in Greece, capital and educated people will leave in a vicious cycle, and Greece's capacity for paying back its debt shrinks by the day. Something has to give.
The only real alternative is Greece leaving the euro, which would have a more devastating effect on the rest of the eurozone (let alone its capacity to pay back its debt) although it might actually be better for Greece itself.
Taking large losses on Greek debt is a tough sell in countries like Germany, Austria, Finland, the Netherlands. But without it, far worse is going to follow. The present strategy is simply criminal, it's keeping Greece in an economic coma merely to keep up the appearance that it will continue to honor its obligations.
To keep that appearance up, ever bigger sums have to be lent to Greece. This simply doesn't make any sense.
The European economy continues to deteriorate at an alarming rate. We have long warned about France (and earlier here). Moody's has not only cut the French debt rating, it has even cut that of the ESM and the ESFS (the European rescue funds). There is considerable policy reform in Spain, Ireland, Portugal, Italy, and Greece, but almost none in France.
The ECB has, as we've long argued, managed to stabilize Spanish and Italian bond yields, but these are still much higher than elsewhere in the eurozone, making financing debt and deficits very expensive, whilst the continuing recession eats away the austerity efforts by reducing tax income and increasing spending on transfers.
The IMF has shown that austerity is difficult when it can't be offset by monetary policy and the economy is already in a recession. It's doubly difficult within the context of the eurozone, where all countries embarking on austerity, capital flows in the wrong direction (from the periphery to the center), and there can't be a realignment of currencies.
This situation is basically a slow asphyxiation. With the ECB promise to unlimited (but conditional) bond buying, the immediate sting seemed to be removed from the crisis but an unraveling of the Greek package could very well do the same.
This can be averted if northern countries were to take steep losses on Greek bonds. They will have to anyway, the sooner the better. With a much reduced debt burden, the perspective for Greece could actually improve considerably. It's difficult to imagine that it could actually get any worse, but that's what's going to happen if the northern countries refuse to play ball.