Two Reasons Why Greece Crisis is Punishing the Euro

By: EW News Desk Team   Date: 23 April 2010

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EW News Desk Team

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23 April 2010

So much for the euphoria over the 'solution' to the Greek crisis with the announcement of the EU-IMF bailout. The markets weren't really convinced, and Greece's interest rates had been ticking up.

So much for the euphoria over the 'solution' to the Greek crisis with the announcement of the EU-IMF bailout. The markets weren't really convinced, and Greece's interest rates had been ticking up. They spiked sharply yesterday when the European statistics agency Eurostat increased the estimate of the 2009 budget deficit from a 'mere' 12.9% to 13.6% - and warned that it could actually be 0.5% higher.

Borrowing costs for a 2-year note rose to over 10%, a figure effectively means Greece can no longer survive without a bailout, and further more that traders now believe a restructure (with a 'haircut' or losses for investors) is likely.

This intriguing article on the Greece Debt Crisis Pushing the Euro to New Lows suggests that there are two reasons for that. Since one of the reasons is based on an EconomyWatch.com analysis, we couldn't help but agree :-)

 

Firstly, Greece is not alone. Oxford Economics estimate that by 2014, total Eurozone debt will exceed 88% of GDP – even without a Greek default. At that stage,Italy would have a 126% debt-to-GDP ratio, actually higher than Greece at 116%, and followed by Belgium at 109%, Portugal at 102%, France at 100% Ireland at 89% and Spain at 81%.

Pretty hefty numbers, right. Even Germany, the richest economy in Eurozone that was looked to for bailouts (an ‘opportunity’ it has effectively declined), weighs in at 74%, not particularly healthy.

Compare that to what the IMF-World Bank model suggests is a healthy debt level for a strong economy; 50% of GDP, two times exports and three times government revenues.

If we are generous we would say that is a challenge. If we are nervous, and we suspect markets will get more and more nervy, then we would say that is untenable.

And remember these are rosy estimates, with no negative Black Swans in the picture. Throw in a surprise or two (and Sod’s Law states that if something can go wrong it will), say Greece or Portugal defaults, another large bank fails, or something else even more unexpected, and that picture can only get worse.

Of course these fears could also lead to positive Black Swans – such as politicians actually deciding they have no choice but to deal with the problem, stomach some stiff medicine and clena up their nations finances. While this could happen – and we hope it does – we are probably still a year or two away from that possiblity.

Which brings us to the second problem.  The Eurozone has a structural crisis, according to this EconomyWatch.com analysis. Put simply, the problem is that the Euro is a currency based on a monetary union, with a European Central Bank, but not a fiscal union.

That means that each government of each Eurozone country decides its own government spending (ie fiscal policy), and therefore whether it runs a deficit and needs to borrow money.

Normally, a country needs to manage both monetary and fiscal policy to manage its economy, and in particular to get out of recession while managing inflation.

Eurozone members have been running different fiscal policies with differing objectives. While that led to some backroom antagonism, it has now exploded into public. It has led to verbal sparring between Germany and France – so much for the Franco-German bedrock of the union.

Having woken up to this reality, the markets are therefore going to get more nervy. That will push up borrowing costs, which will led to more pressure and probably more flare-ups. There is clearly a vicious cycle in play, and since no one in the Eurozone can unilaterally solve it – it will take time to reach a consensus, all part of the structural problem – the pressure will build.

UPDATE: The Greek government has just formally called for the EU-IMF bailout package to be activated. Talks are going on around the clock between the three parties to formalize the details. Up to $60 billion will be accessible. The yield on the 10 year note dropped from around 9% to 8.1% on the news.


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