Monday 27 June 2011

Will Greece have to default?

The answer to this is yes and it is only a matter of when, not if.  At least that seems to be the view of most economists.  At least those not employed by the EU, the ECB or the governments of the member states.  It is easy to see why.  Partly as a result of the austerity measures that the EU and IMF wish to inflict on Greece, there is simply no way in which the Greek economy can grow sufficiently to generate the funds to repay all these loans.  Which of course makes it all the more likely that Greece will reject the proposals.  Even if they are forced to accept them, the austerity measures, it merely delays the inevitable.  At some stage in the not too distant future, Greece will have to default.  And all hell is likely to break out.
The reason for this is that if Greece defaults then some of the big French and German banks will be in deep trouble.  And the reason for this is that any kind of default or rescheduling of debts would force the banks to come clean on their losses.  It is unlikely to end there, as a Greek default would almost certainly have a domino effect and lead to similar troubles in Ireland, Portugal and possibly Spain and Italy.  To get an idea of how losses in Greece can affect banks elsewhere, please read this article by David Malone on his Golem XIV blog.
So the EU is desperate to keep Greece from defaulting, hence all the repayable loans it wants to force on the Greeks.  Getting the already impoverished Greek taxpayers to bear the whole burden is quite cute, at least if you can get away with it.  For remember, it is not in fact Greece that is getting bailed out, it is the bondholders, primarily the French and German banks who so recklessly leant the money to Greece in the first place.
However the likelihood is that by trying to stave off the inevitable, EU leaders are only making this worse in the long run.  Preventing contagion spreading to Ireland and Portugal may be impossible due to current EU policy.  Colm McCarthy, an Irish economist gives a good outline of how this failure to face up to the reality of a Greek default will make things worse, in this article for the Sunday Independent.  He also makes the interesting point that this failure stems in part because, “European political leaders are reluctant to admit to their electorates that the euro system was poorly designed from the outset, that some countries should perhaps not have been admitted at all and that there have been massive failures of bank supervision.  French banks apparently hold €56bn in Greek bonds, German banks €30bn.  Why were they allowed to acquire these huge exposures?”  It is just so much easier to blame poor feckless Greeks and gullible Irish.
So what is likely to happen?  The smart money is on some kind of break-up of  the Eurozone.  Some of the peripheral countries will be forced out or voluntarily decide to leave the eurozone.  This would come along with a default.  While this would clear these countries’ sovereign debts, it is not clear what the long term consequences would be.  The thinking behind this is that a much reduced eurozone - Germany, France, the Netherlands, Austria, Belgium - would not face the same strains and stresses of the current, wider zone.  It would however still be faced with the same basic problem.  Can a monetary union survive without a fiscal union?  This would need the creation of European Finance ministry and would allow for fiscal transfers between member states.  As is the case with the USA.  While the current climate within the EU is hostile to such a move, perhaps within a core eurozone it might be easier to sell this plan to the electorates.  Short of some kind of fiscal union the euro is likely to be doomed.  As the creation of the euro was essentially a political decision, expect politics, especial the need to maintain the Franco German axis, to play a large part in any future decisions.
In the meantime, Europe needs to prepare for the worst.  And this will alas include the UK.  Since what we face is a solvency crisis, Europe needs to expunge the rot from its banks.  This is the conclusion reached by John H Cochrane and Anil Kashyap, two professors of economics and finance at the University of Chicago Booth School of Business.  In an article for the Wall Street Journal they highlight some of the key facts in this sorry Greek tragedy.  Whatever the long term solution for the EU, some time soon, and the sooner the better, banks need to get their houses in order.  As they put it, “Banks with inadequate capital must raise it, find buyers, or reorganize.  If that means bailouts of ‘systematically important’ banks, then governments must do so, face their taxpayers, and make their regulators explain how they let this happen.”  
I like that last bit, about making regulators explain how they let all this happen.  I would go further and where possible charge them with gross dereliction of duty.  At the very least they should no longer be employed as key government advisers.

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