Jun 18 2011

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Between Greece and Calamity

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Breath easy, people.

After unsettling weeks of public brinkmanship, European governments have come up with a plan to stave off Greek default.

By all means, let’s get back to the important business of the Weiner tweets….

Germany’s quarrelsome Chancellor, Angela Merkel, who quaintly insisted that all parties – public and private – collectively share the pain of any fresh public bailout, caved on Friday.

Instead of Merkel’s realistic plan, Germany reluctantly agreed to the less painful option of encouraging  private debt holders to simply extend the maturities of their existing debt, or payoff maturing debts with new Greek bonds, with the European Central Bank (ECB) providing yet more money to Greece.

By spairing the private sector a “haircut,” the EU governments hope that a grateful cohort of investors will repay government restraint by staying in Greece, instead of the saner option of running for the doors. In theory at least, this would limit the size of the bailout that European governments would need to pony up to keep the Greeks afloat.

The German concession clears the way for a fresh aid package to Greece.

That is, until next time.

And there will be a next time.

The actions by the European Union, led by Germany and France, are but a band-aid on a sucking chest wound.

The new agreement deals with the most immediate issue – an imminent Greek default – but in the larger scheme, it only postpones the day or reckoning by a few months.

Greece is in the throes of a structural solvency crisis that no amount of German, ECB or IMF money can fix.

The country’s debt-to-GDP ratio tops 150%. 

To put that in perspective, you would need to take the entire value of all goods and services produced by Greece over an 18 month period in order to settle its accounts. It is simply a staggering debt.

In May, 2010, Greece implemented preliminary austerity measures in an attempt to bring its budget into balance in return for financial assistance from the EU.

Despite these measures, which sparked widespread protests and social unrest, Greek government spending was actually up 3.6%, while revenues have dropped 9.1%, sparking the latest crisis.

The root here is not simply fiscal but societal.

According to the Wall Street Journal, less than 60% of the eligible Greek citizens actually work. Of those that do, fully 30% are unionized civil servants, who until recently enjoyed early retirement and choice, Cadillac pension plans, which were the catalyst for prolific government spending that sparked deficit crisis to begin with.  

These predicates, in turn, have made Greeks some of the least productive workers in the West. 

According to the OECD, in 2009 Greek workers produced $34.2 worth of goods and service per hour – compared to $53 in Germany and $56 in the US.

This is simply not a winning formula for successful belt-tightening and dynamic growth necessary to climb out of a financial death spiral.

Despite these inhibiting systemic challenges, the Greek government has now committed to even greater austerity in return for the latest EU cash infusion; placing financial reality on a collision course with Greece’s disintegrating social compact.

The result will be an even great default risk before the end of 2011.

And that matters, as Greece is the likely first domino that will set off a contagion within the highly integrated global financial system.

To paraphrase Keynes, if you owe the bank a small amount, the bank owns you.  You owe the bank a huge sum, you own the bank.

Greece effectively owns the global financial system.

Consider that German and French banks hold $89 billion in Greek debt.  The French hold the most, $56 billion (which of course has nothing to do with French insistence that bond holders be held harmless in any new aid package).

Before a deal was finally struck on Friday, Moody’s had warned that three French banks  BNP Paribas SA, Crédit Agricole SA and Société Générale SA, were at risk of being downgraded due to their outstanding Greek debt.  Credit Agricole alone holds an eye-popping $31 billion of France’s total Greek debt.

So any Greek default is going to hit these institutions hard. So, looking at the institutions in total, where do these banks get their liquidity for short term financing?

US money market funds.

US money market funds had an exposure of $361 billion to Euro-zone banks in May. The three top French banks account for 25% or $91 billion of this total.

That’s not chump change.

By way of comparison, the US investment in French banks is more money that the USG spent bailing out GM and Chrysler. The total investment in Euro-zone banks is $100 billion more than US banks required under TARP.

Now, by law, US money market funds are only permitted to buy the highest rated short term debt.

That means that if French or other European banks appear to be headed for a downgrade, US money market funds will conceivably divest themselves of these institutions based on perceived risk, hitting international markets with a credit conundrum.

If the downgrade due to Greek debt is real, the US will pullout at just the moment those Euro banks will face the danger of a real liquidity crisis as a lower credit rating will require higher interest rates to attract capital. 

A flight to safety will ensue as capital quickly escapes the downgraded institutions in serial fashion for more secure locations.

That will put enormous pressure on inter-bank lending, which, with a asset flight to safety and increased interest rates to attract capital will likely lead to a freeze in the credit markets, not unlike 2008. That will significantly impact global lending, and eventually hit the US market, with damaging consequences for the US economy.

But is the scenario real?  Will the Euros really allow this to happen?

Consider that as of May, US money market funds have already pulled out of Greece, Portugal and Ireland entirely. Lending to France is down 9%, Germany, 25%, Italy 75% and Spain, a staggering 85%.

Follow the money and you will find the future. This is the breadcrumb trail to the future, staring at us right now.

As if to accent the flight of US cash, Moody’s Investor Services placed Italy – the Euro zone’s third largest economy – on notice Friday, warning that its sovereign rating may be imperiled by a weak economy, tenuous financial consolidation and risking interest rates.

At the end of the day, it is human nature to block out the unpleasant in favor of hope. 

To that end, today’s Washington Post featured a hoepful article titled, “Leading indicators higher in May after April’s dip, point to moderate growth through fall.”  The article detailed the Conference Board report of economic indicators that showed a .8 increase, after .4 decrease in April, singalling tempered growth through the fall. Normally a string of monthly declines indicates a coming recession.

So, no worries, here.  Indeed, who knows what has happened with Anthony Weiner since you’ve been reading this post?

But in prioritizing isolated good news amid structural bad, we fail to see the larger warning signs that could derail any sustained recovery.

Not only is the sovereign debt crisis in Europe a clear and present danger to the US economy now, the origins of the crisis serve as a stark parable for our own country if we refuse to reconcile our financial reality to our unsustainable social commitments.

We have been warned.


Trouble Over the Horizon



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  1. Eulalia Daubendiek

    Now i’m from Germany and we can be very very pleased that the Chancellor has gotten the highest civilian merit by the Usa. Even if the nation-wide politics of Chancellor Merkel in my opinion isn’t good, appreciate it United states

    1. C2

      Eulalia: I am most pleased that you stopped by to visit my blog, and I hope you will come back.

      I have nothing but esteem for the Chancellor. I believe she understands the underlying economics of what is going on in the Euro-zone better than most, and she also knows that at the end of the day, in order to save the Euro, it is you – the Germans – who are going to have to pay.

      You worked hard, played by the rules, lived within your means. Its not fair. You shouldn’t have to be on the hook. But you are the only country rich enough in the Euro zone. But I guess it doesn’t really matter as the Greeks will never meet targets that will bring the crisis to an end without chaos.

      I believe we Americans face a Greek-like crisis for our own prolificacy and unwillingness to come to terms with the cost. I hope we have the courage to resolve it before we run out of time.

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