Tuesday, May 10, 2011

We smell smoke

First, before we go any further please cast your minds back to this blog exactly a year ago and we ask you to reread THIS posted on 10th May 2010.

It was to the day that the markets were responding positively to announcements of European rescue packages designed to support the ailing periphery whilst they implemented austerity measures designed to cut their internal debts to levels that made it serviceable in the long run. And to wit, MM commented at the time:

As always in the Eurozone, conditionality and enforcement are paramount issues that will be tricky to solve. No doubt Portugal, Spain, et al. will say the right things and appear to toe the line...but what happens when growth undershoots and so do fiscal revenues? Which will give way...living standards for civil servants, or fiscal rectitude? (This, as an aside, is the primary argument for IMF involvement: so the German's won't have to play "bad cop").

Now we have always known that it has been a tightrope for the peripheral Governments to walk. Not enough talk of implementing austerity and the desperately needed emergency funding will not be forthcoming... No actual austerity and there will be no improvement in debt burden and no long term solution. Against which, too much austerity will see a public backlash which could kick out the Government and result in economic mob rule (as has happened in Iceland where public referenda are used to decide whether international debt should be repaid; result is Ms Dottirdottir saying "Nei").

For the past year the Greek government has been playing the population off against the European creditors. But just as a teenager will promise his mum he has stopped smoking in order to collect the $100 promised for doing so, while just sucking on mints to cover the smell, Greece hasn't stopped the rot at all and the wafts of peppermint no longer shroud the stink of smoke from the utterly horrendous data out recently from Greece (Nominal GDP -2.1% vs 5%+ financing rates, Real GDP -6%). TMM's suspicions and concerns from last August in their "Postcard from Greece" now appear fully justified.

So the European debt collectors have started knocking on the door but have arrived to be greeted by a debtor threatening to trigger the suicide belt of leaving the Euro, causing collateral damage that threatens the very foudantions of the building. Recent comments have TMM's nostrils twitching to the smoke coming from a bushfire:

  1. (The above mentioned Greek data is utterly horrendous.
  2. Bini-Smaghi and Nowotny suddenly are not sounding like central bankers anymore, very odd - almost "panicked".
  3. The Friday meetings was with the big guys alone, and were vehemently denied even as they happened - seems like desperation.
  4. Continued dialogue from respected economists and politicians about how such austerity has never been unaccompanied by debt forgiveness.
  5. Discussions by ratings agencies and bank economics departments that maturity extension alone is insufficient to regain fiscal solvency.

TMM have thought hard about the current strategy of increasing aid and extending maturities and now think there is an increasing probability that the Eurostriches are finally recognising we are on the following path that ends with "Lions".

  1. EU institutions keep rolling over Greek loans and extending maturities.
  2. Private debt stock gets gradually paid down.
  3. EU institutions end up holding a very large amount of outstanding Greek debt stock.
  4. Greece is unable to get any or all of (i) enough Growth, (ii) enough tax collection, (iii) enough spending cuts etc.
  5. EU institutions are forced to take a large haircut on the debt stock.
  6. Political crisis of the EU when it becomes clear that the EU has to take a hit of EUR150-200bn (to put this into perspective, the EU budget is EUR133bn...).

That doesn’t only threaten the existence of the EMU, it could ignite the EU. TMM are seriously worried that the Eurocrats have moved into the depression stage of grief over the loss of their investments, both financial and political, in their Euro project and it will not take long to move from the depression stage of grief to the "acceptance" stage. We - like many now - feel that a new Greek package that includes an agreement on private participation is coming soon as it will be easier, politically (not just domestically, but also in terms of "The European Project"), for France and Germany to justify bailing out their own banks directly (blaming Greece) rather than justify bailing out Greece directly again for another year.


Anonymous said...

I think you have joined up the dots on one scenario and one of the most likely couple of options that have any decent probability of happening.
What concerns me really is if the Greek debt is handled like this then what is the consequence for Irish and Portuguese debt?

Sid said...

"No actual austerity and there will be no improvement in debt burden and no long term solution."

Either is unlikely to happen under the current European monetary system, with or without austerity. The problem's not with the governments being too profligate, but with economies being forced to adjust through wage-price adjustments, rather then much more efficient and politically feasible currency devaluation.

Frankly, I don't see how the Eurozone can survive in its current form for any meaningful time. Either the currency union will be restructured in an orderly fashion (two currencies, return to national currencies with the euro left for international transactions or extra-EU transactions etc.) or it will suffer a disorderly dissolution/shrinkage.

Leftback said...

It is odd to see markets trundling along here as though they are blissfully unaware that we are fast approaching checkmate in the chess game of Euro debt crises. It would be vastly preferable to eject Greece and other peripherals and thus enable the desperately needed devaluation of the reissued drachmas and punts, etc, or a Euro-north and Euro-south type of solution. The European banks are going to take a big hit whichever route is selected, which is why the ECB is now effectively in checkmate.

Sid said...

Quote LB: "fast approaching checkmate in the chess game of Euro debt crises"

Why would we? As long as politicians in the core are willing to provide money to the periphery, the situation can go on and on. And they will be willing to do it until they deem their banks and pension funds capable of taking the hit you are talking about.

Also, the politicians seem to be somewhat irrational (to a degree) from economic point of view and just cling to current eurosystem for the sake of whatever political investments were made into it. Things like that happen quite often, unfortunately, though they always end with economics trumping politics.

So, I doubt we're going to see the checkmate soon.

Anonymous said...

Unfortunately,I really do not see how we can arrive at any particular scenario for the greek debt in a way that is useful for us. Out of the options available I would not know where to start to give them some form of probability as to occurrence.Therefore all I can do is keep giving European banks a wide berth.

Leftback said...

"So, I doubt we're going to see the checkmate soon."

That's sort of the point of the chess analogy, Sid. You can see checkmate approaching as the game develops even though you can't predict how many moves will occur first and its inevitability is not altered by that aspect of uncertainty.

As in the US crisis of 2008, you knew it had to happen, the question was which one of the dominoes would unwind all the leveraged trades, and it turned out to be Lehman.

Rene Korda said...
This comment has been removed by the author.
Sid said...

The 2008-style unwind would probably require something really sinister happening to Spain - sinister enough for the core countries to not be able to manage the bailout. Otherwise, I'd say we might either have a 2010-moment or no collapses at all, if the system is reconstructed (or deconstructed) in an orderly fashion.

Not that I have much faith in the latter, as European politicians consistently demonstrate considerable talent for collective screw-ups.

Anonymous said...

After the commodity selloff today looks like a reset day with Greece being relegated to a what is that to with us role.

Leftback said...

Today certainly looks like a beginning of the inevitable retracement for the USD, with commodities making their predictable bounces and anyone silly enough to stay short being squeezed. A classic exit rally in progress, surely only the truly unwary and frequent visitors to Peak Oil, GATA, Dollar Apocalypse and Chicken Little blogs will initiate new positions here.

Another good day to sit and count your toenails, and watch dividends and T-bills... zzzzz

Anonymous said...

Those TBills now look like getting a bit more interesting.