As the haze and rhetoric surrounding the Greek debt crisis begins to lift we can now paint a pretty good picture of what's in store over the next few weeks for Europe's seemingly never-ending debt saga.
The June 29 Deadline
The FT describes the latest details and deadline in the Greek debt endgame:
... pressure is building to have a deal done within three weeks because of an IMF threat to withhold its portion of June’s €12bn bail-out payment unless Athens can show it can meet all its financing requirements for the next 12 months.
Officials think Greece will be unable to return to the financial markets to raise money on its own in March – as originally planned in the current €110bn package – meaning that the IMF is now forbidden from distributing any additional cash. Without the IMF funds, eurozone governments would either be forced to fill the gap or Athens could default.
To bring the IMF back in, the new deal must be reached by a scheduled meeting of EU finance ministers on June 20.
The hard deadline may in fact be June 29, when a 12 billion euro ($17bn; £10bn) payment is due to be made to Greece, of which 3.3 billion euros would come from the IMF.
Driving the IMF's credible tough stance are hard lessons learned (and apparently not forgotten) in Latin America a decade ago.
Paul Blustein has written two very insightful and accessible books on recent sovereign defaults and IMF bailouts. His first, titled "The Chastening," details the 1997-1998 Asian financial crisis. His follow-up focussed on the financial crisis which struck Argentina's shortly thereafter, and is titled "And the Money Kept Rolling In (and Out): Wall Street, the IMF, and the Bankrupting of Argentina."
Blustein's insider view provides a behind-the-scenes look at the IMF's mindset and how recent IMF experience has a heavy influence on the Fund's next policy response. One of the the country models the IMF is using to evaluate how best to handle the Greece situation is Argentina circa 1999-2001. Former IMF chief economist and MIT professor Simon Johnson (and colleague Peter Boone) made the following comparison between today's Greece and Argentina's situation from a decade ago:
There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties. The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment.
At the end of 2001, Argentina’s public debt GDP ratio was 62%, while at end 2009 Greece’s was 114%. Argentina’s public deficit reached 6.4% GDP in 2001, while Greece’s was 12.7% GDP (or 16% on a cash basis) in 2009. Both countries locked themselves into currency regimes which made it extremely painful to exit: Greece has the euro, while Argentina created a variant of a currency board system tied to the U.S. dollar. And both countries had seen their competitiveness, as measured by the “real exchange rate” (which reflects differential inflation relative to competitors) worsen by 20% over the previous decade, helping price themselves out of export markets – and boosting their consumption of imports. In 2009 Greece had a current account deficit equal to 11.2% of GDP, while Argentina’s 2002 current account deficit was a much smaller 1.7% GDP.
In short, Greece is in much worse shape than Argentina. Here are some of the lessons the IMF took away from the Argentinian debacle:
... the Fund should have walked away from weak government policy programs earlier in the 1990s. Most importantly, IMF experts argued that from the start the IMF should have prepared a Plan B, which included restructuring of debts and termination of the currency board regime, since they needed a backstop in case the whole program failed. By providing more funds, the IMF just kicked the can a short distance down the road, and likely made Argentina’s final collapse even more traumatic than it would otherwise have been.
The Argentinian experience is one not to be repeated. A "financial crisis" generally occurs in one of the following three areas: exchange rates, banking system and sovereign debt. A country which experiences a dual-crisis, say in exchange rates and the banking system, is considered particularly hard hit. Argentina achieved the rare and inglorious macroeconomic distinction of having a banking, currency and debt crisis all at the same time. Bloodshed in Argentina unfortunately followed.
As Professor Johnson has put it, "the IMF always gets paid back." The Fund's analysts have no doubt done their research and calculated the probability that Greece can pay down a debt-to-GDP level which will now purportedly peak at 160% as nil. Perhaps the only country to ever come out of a similar debt level in the past century was post-WWII Britain, which only managed to do so through severe financial repression, substantial U.S. financial support, and multiple currency devaluations of 30% or more.
Colliding head-on with the IMF's resolute stance is Greek national character. The 'new deal' described by the FT includes the surrender of some of Greece's sovereignty:
European leaders are negotiating a deal that would lead to unprecedented outside intervention in the Greek economy, including international involvement in tax collection and privatisation of state assets, in exchange for new bail-out loans for Athens.
Anyone who knows the Greeks will recognize that the idea of turning over tax collection to foreign technocrats is not going to sit well in the streets of Athens. This disagreeableness will only be compounded by the fact that the whole purpose of engaging in a fire sale of state assets is to replenish the coffers of French, German and other foreign banks, as well as the European Central Bank, which has purchased €47 billion of Greek debt.
Recent news suggests a climax is near. While the WSJ just reported that Angela Merkel's government will back a second Greek bailout, broad public support in Germany for further bailouts has deteriorated. Germans, Finns, Dutch and other northern Europe taxpayers are outraged at sending more money to Greece while protesters in Athens demand earlier retirement benefits and Greeks continue evading taxes. How long will northern European taxpayers abide as substitutes for Greek taxpayers?
Meanwhile, on Wednesday Greece's EU commissioner publicly suggested that leaving the Euro was "on the table", while on Friday the Greek government failed to agree on new austerity measures. It's unclear whether Greece even has title to the state assets which northern Europe is insisting the Greeks sell, and there is also significant political resistance to broad Greek assets sales in general.
Unlike this time last year, everyone now knows that any new plan which does not include a restructuring of Greek debt lacks credibility. In short, the game is up. A Greek default is both imminent and necessary.
What Happens When Greece Defaults?
It's impossible to say for sure as it will depend upon the specifics, but here's a sampling of just a few of the bleaker possibilites outlined by the Telegraph:
- Every bank in Greece will instantly go insolvent
- The Greek government will nationalise every bank in Greece
- The Greek government will forbid withdrawals from Greek banks
- To prevent Greek depositors from rioting on the streets, Argentina-2002-style (when the Argentinian president had to flee by helicopter from the roof of the presidential palace to evade a mob of such depositors), the Greek government will declare a curfew, perhaps even general martial law
- Greece will redenominate all its debts into “New Drachmas” or whatever it calls the new currency (this is a classic ploy of countries defaulting)
- The New Drachma will devalue by some 30-70 per cent (probably around 50 per cent, though perhaps more), effectively defaulting on 50 per cent or more of all Greek euro-denominated debts.
The below chart from Barron's provides some details on exposure to Greek debt.
Large derivates playeyers listed above, like Society Generale (SCFLF.PK) and Deutsche Bank (NYSE:DB), may be excellent candidates for shorting as they are likely sitting on Greek some credit default swap exposure. There is also the iShares MSCI Europe Financials Sector Index ETF. And I continue to believe that a short postion against the Euro versus various currencies (i.e., U.S. dollar, Swiss Franc) is a smart play.
The Silver Economic Lining
As bleak a picture as this all seems for Greece, experience suggests that economic recovery can begin relatively quickly after the hard decisions have been made and losses accepted. Returning again to Johnson's and Boone's story of Argentina after the financial meltdown:
Argentina’s economic collapse ended roughly six months after they defaulted and ended their peg. While it was painful, the economic recovery started rapidly; nine months after default and devaluation, GDP began growing rapidly. This is a trend that continues even today. The same lesson, that large devaluations and default can result in rapid recoveries, was observed in Russia in 1999, and in the aftermath of the asian crises.
Greece can also turn to nearer and more recent examples of Iceland and Latvia, both of which took their tough medicine early on and appear to be recovering quickly.