Greece and Italy Suffer: Let the Game of EU Chicken Begin

Exactly one year ago, I spoke to an audience of investors at the local money show in Athens, Greece. I told them that, over the next 10 years, there is a big possibility that Greece and Italy would voluntary leave the euro. Everyone's jaw dropped!

My logic was simple. If and when we get a big rescission in Europe, these two economies would not be able to handle it. As a result, there is a big chance that they will leave the euro to be able to print drachmas and liras in order to meet their obligations… mostly to their citizens.

Well here we are one year later and already Greece and Italy are in great financial pain (if not on the verge of an economic collapse).

While the euro is a great currency and offers many benefits to those economies that have it, the euro also requires fiscal responsibility and other obligations. For one thing, you can't be part of a strong currency block of nations when you are not competitive.

So far the EU (did anybody say Germany) has washed its hands and has sent the message that every country must clean up its own mess. Greece has responded by announcing a bank package to help its local banks. Basically Greece will issue government bonds and give them to the banks and then the banks can post them as collateral to get funding.

However, as much as €40 billion of Greek government debt comes up for renewal in 2009. Will Greece (and Italy) be able to refinance this debt? Chances are they will, but at what price?

Already the CDS spreads that measure the possibility of country default are about 250 for Greece, leaving even Italy far behind! Even if Greece is able to find the money it needs in 2009, what will that do to its public finances and its ability to meet its social obligations?

You probably all saw the riots in the streets of Athens the past month. That's nothing compared to what will happen when (not if) the government announces that retirement benefits for the Greek public sector will have to be axed at some point.

If Germany and the EU insist that Greece and Italy handle this market turmoil by their own, then chances are that at some point in the future, these economies will break down and (reluctantly) be forced to exit the euro in order to be able to print money and meet obligations.

Like I said, so far the EU is playing hard ball and will not help Greece (or Italy) in any way.

You all know how the game of chicken is played don't you? It goes like this.

Two cars at great speed race towards each other in a head on collision. The one who gets out of the way looses. The winner is the one who had the nerve and the lack of self preservation and carried the game to the end.

Now let's say that Greece and Italy struggle on their own and this recession continues for more than we all bargained for. Chances are that Greece and Italy, at some point in the future, will voluntary leave the euro to print their own money to meet obligations.

What does that mean for European banks?

Well European banks have at least €800 of Italian and Greek debt on their books. If these two countries leave the euro, you can bet that their bonds will lose at least 60% of their value. This means you can say goodbye to the European banking system (what's left of it) and say goodbye to the euro.

So the question is this: Will Germany and the EU let Greece handle the financial crisis by itself, only to be forced out of the euro in several years, or will they step in and help, in order for Greece (and Italy) to overcome this very difficult period?

My bets are that they will do whatever is possible to help. When you have nothing, you have nothing to lose. Greece and Italy at this point have nothing left to lose. The EU and the German hardliners however have everything to lose, if they allow the situation in Greece and Italy to get out of control.

So getting back to the game of chicken, I think a head on collision will be averted, because Germany and all the other EU hardliners will come to their senses and realize that, they have a lot more to lose by a head on collision then they would by averting one.

In either case, the EU hardliners will lose anyway, but by stepping aside and letting Greece and Italy win, they simply lose less.

Comments

[morph366:]

Interesting article but I wonder why you state the following with such certainty

<i>If these two countries leave the euro, you can bet that their bonds will lose at least 60% of their value. This means you can say goodbye to the European banking system (what's left of it) and say goodbye to the euro.</i>

It would be messy but those with eurozone obligations could get over it.
Much more risky for Greece and Italy to try to persuade money markets to buy bonds denominated in their old pre-Euro currencies.

2008 Dec 26 08:04 AM

[robinjoe:]

Interesting article.
I presume that the European banks will go under due to them holding massive amounts of Italian and Greek bonds?
Everything is seeming to unravel at once all around the world.

2008 Dec 26 08:56 AM

[Pavlos:]

At least regarding Greece, the bailout numbers are so small they can hardly make a difference in the wake of the turmoil going on in the rest Europe. Italy will never drop out of the Euro for national pride reasons and Greece cannot afford to have rival Turkey be in (eventually) while she's out. The solution for both is a bridge loan from the IMF, easily justified given the current circumstances.

2008 Dec 26 12:22 PM

[cnic:]

I am sorry George Kesarios, but this is a badly written and cynical article based on exaggerations. It is easy to be cynical and to sensationalize the situation. Your suggestion that the Greek And Italian governments will even consider leaving the Euro to print more Lira and Drachma is a short-term solution with no lasting positive effect. Staying in the Euro is a long-term option. What makes you think that the Italian and Greek government would even consider leaving the Euro to pay even higher spreads (which you yourself suggest will happen). Also how did you derive your figures of a 60% fall in bond prices? I even question your 800 billion figure. Did you pull these figures out of your behind? The Euro is benefiting counties with a high debt not straining them. Greece and Italy will most likely tighten and spend public money more efficiently and try to get more money from tax evaders. Greece is still planning to keep its budget deficit below 3% of GDP and even the most pessimistic economist still predicts positive growth for the Greek Economy in 2009 even though most of its partners are in recession. And lets not assume that the world will not be in recession forever. I am sure both economies will ride out the storm because they are in the Euro, especially considering their banks were not directly exposed to losses from mortgage products and will not need to borrow as much capital as you suggest.

2008 Dec 27 02:31 AM

[George Kesa...:]

Cnic, you are correct, this is an exaggeration on my part. It’s a scenario of extremes so far, but I am afraid that if Greece doesn’t get its act strait, it might become a reality. But like I said, we are in the middle of a game of chicken and I am sure that in the end the EU will help Greece pull itself out of its predicament.

I am not suggesting that Greece and Italy will leave the euro because they want to, but that they might do it out of necessity.

As far as the 60% drop in bond prices, I think its conservative, especially for Greece.

And yes (as another reader said) Greece’s bond market is insignificant by itself, but with Italy in the picture, it is a serious matter.

Indeed, the euro has benefited Greece in many ways, but the problem is that Greece is in a very dangerous situation with the very high debt. Need I remind you that Greece (with Italy) have the highest level of debt among the OECD block.

My hope is that the Greek government comes to its senses and initiate reforms as such to avoid the worst possible outcome. However, until I see such reforms, I am not very hopeful that many things will change.



On Dec 27 02:31 AM cnic wrote:

> I am sorry George Kesarios, but this is a badly written and cynical
> article based on exaggerations. It is easy to be cynical and to
> sensationalize the situation. Your suggestion that the Greek And
> Italian governments will even consider leaving the Euro to print
> more Lira and Drachma is a short-term solution with no lasting positive
> effect. Staying in the Euro is a long-term option. What makes you
> think that the Italian and Greek government would even consider leaving
> the Euro to pay even higher spreads (which you yourself suggest will
> happen). Also how did you derive your figures of a 60% fall in bond
> prices? I even question your 800 billion figure. Did you pull these
> figures out of your behind? The Euro is benefiting counties with
> a high debt not straining them. Greece and Italy will most likely
> tighten and spend public money more efficiently and try to get more
> money from tax evaders. Greece is still planning to keep its budget
> deficit below 3% of GDP and even the most pessimistic economist still
> predicts positive growth for the Greek Economy in 2009 even though
> most of its partners are in recession. And lets not assume that
> the world will not be in recession forever. I am sure both economies
> will ride out the storm because they are in the Euro, especially
> considering their banks were not directly exposed to losses from
> mortgage products and will not need to borrow as much capital as
> you suggest.

2008 Dec 27 05:25 AM

[Dr. Realist:]

Ho Hum. The Capitalis system held together with haywire and spit, and another ho hum

2008 Dec 27 12:55 PM

[User 326724:]

Can someone tell me why Germany, ex barbarians and all becamme a super power, had their country destroyed in WW2 and than again became a superpower, while Greece is still sucking it hard. Why cant we bcome a superpower and start manufacturing our own cars, clothing, food at a massive scale for exporting, what's the problem, I dont get it. We have Sweden building jets and cars and other little ex barbarian countries making more money or balancing it better than us , what the heck is the problem, we dont have anymore turks up our butts, can someone explain this to me please.

2008 Dec 27 08:38 PM

[Econ Base:]

If you look back in history, Eurozone is a creation of France and Germany based on political desire and not financial realities. A single currency means laws, labor productivity, labor standards, infrastructure etc. are rather similar across the currency zone. Even in America you will find differences between say California and Missisippi. The impact of the differences are subsidized by the stronger geography. Easier done when it is one country. Very difficult when nationalism comes in the way. The author is absolutely correct: Either Germany, Luxembourg etc.subsidize these less productive countries, or they get kicked out (or kick themselves out) which is a a difficult option, but inevitable. There is a reason why Norway and Switzerland did not become part of the Eurozone. They were not interested in subsidizing these "siesta loving" countries. Although the pound is not immune, but they also were smart to look across the Altantic for future rather than across the channel. Move out of Euro into Dollars, Yen and Gold before it is too late.

2008 Dec 29 02:33 AM

[Steven Morson:]

The game is up, and the tide is turning. The Euro has nothing whatever to do with economics and everything to do with politics. This is why it is facing collapse now.

It always was and is nothing more than an instrument of control by global corporates, to extend their influence and create a world of just several strongly-regionalised markets. With the EU, they have an easily manipulated stratum of bureaucracy with which to control 400 million people, and all with the same currency. This, believe it or not, is propounded by the Europhiles as being ‘a wonderful thing’, and ‘the only way we can tackle global issues such as trade and climate change.’ What garbage!

How on Earth can one interest rate suit Germany and France in the same way as Portugal, Italy and Greece, the three front-runners to drop out of the Euro (which, by the way, everyone was told was “impossible” before joining!)?

As long as I draw breath, the UK will never join the Euro, it is not in our interests. Too much has been done in my country with the EU through lies and deceit, and we pay more for this than anyone except Germany. It is time we were out.

Jan 19 07:18 AM