Even before the current Greek PSI, everyone knew that Greece would need massive debt relief. Before the recent Greek haircut, total Greek debt was about 380 billion euros. After about 100 billion euros in sovereign debt write-downs, current Greek debt today stands at around 300 billion euros. For a 200 billion euro economy (if not less), Greece's Debt/GDP ratio is still at 150%. Under no circumstances is Greece's debt sustainable.
Yesterday, as reported by Reuters, the CEO of Commerzbank (CRZBF.PK) said Greece needed another haircut. This is no surprise to many, including myself. I was calling for about 200 billion euros in Greek debt relief months before the latest haircut took place, in order for Greece to have a chance to be solvent.
Please recall that I am of the opinion that Greece will not leave or be kicked out of the eurozone. I am still of this opinion, for there are no alternatives. Even if means many more Greek haircuts and even if eventually Europe has to conceive some kind of a Marshall plan for Greece, it is preferable on a cost benefit analysis basis to keep Greece in the eurozone. However, even if Europe does indeed solve the Greek problem and soon, there are still many issues ahead.
The long awaited European banking union - a European FDIC type institution - is still some years ahead. Politics in Germany stand in the way of many of these changes and in the middle of all this, chances are that Europe will be in a recession this year. Ireland is also fighting for its own debt relief package, but again, Germany does not want to hear about it.
A European fiscal union is still very far away. Even within Europe, taxpayers within countries do not want to share with other parts of their own country. As such, there is still much hesitation for a full fledged European federal structure at this time. It will eventually happen, but it is still very far away.
In the meantime, Italy and Spain do not want to seek assistance unless rates surge once again and they are both locked out of the markets. Under no circumstances do they want to be forced into Greek style draconian budget constraints.
Yields on both Italian and Spanish bonds have come down about 200 basis points after Mario Drahgi said he was willing to purchase unlimited quantities of Italian and Spanish debt on the open market. But if both countries do not lower their deficits, eventually even the ECB will not be able to help, unless of course the ECB wants to be the only buyer of Italian and Spanish debt.
In the midst of all this, one thing is for sure, Greece needs to be backstopped because Greece is the fuse that might blow the European Union to smithereens. If Europe takes care of the Greek problem, then ECB policy will probably gain permanent traction in Spain and Italy, even thought I don't think that simply buying debt on the open market to lower rates is the long term answer.
The Greek budget defect is still far from closing. Europe insists that Greece has to have a positive primary surplus. This is harder said than done. Imagine for example if the U.S. had to close its budget deficit. If the U.S. government had to lower expenses by about $500 billion per year for the next 2-3 years, chances are that the U.S. GDP would shrink as much as the Greek GDP did.
And Greece is not the only country that has a deficit problem. Almost every single European country faces a budget shortfall that needs to be addresses. With Europe in danger of sliding into a recession, it's hard to see how politicians will be able to handle current deficit issues and please the markets at the same time.
There are no simple answers for Europe's woes and for the most part, politicians do not have the stomach for hard choices. And when they do make choices, they are either the wrong choices or too little too late.
Finally, with central bank money printing at full capacity on both sides of the Atlantic, it is difficult to conclude which way the EURUSD pair will go. I still think that the euro deserves to move up against the dollar from current levels, but if Europe falls into deep recession, all bets are off.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
