|
Friday, April 23, 2010 www.stratfor.com
|
|
G REECE HAS NOT HAD MANY
GOOD DAYS in 2010, but Thursday was a particularly bad day. First,
Europe’s statistical office (Eurostat) revised up the
Greek 2009 budget deficit, which placed Athens’
accounting shenanigans in the spotlight again. The bottom line is that the
situation is even worse than previously thought, and the budget deficit may
very well be adjusted up as more Greek accounting malfeasance comes to light.
Following the announcement, credit rating agency Moody’ s dropped Greece’s
credit rating one notch, immediately prompting a rise in Greek government bond
yields, thus increasing Athens’ borrowing costs.
The yield on a Greek 10-year bond
shot above nine percent, while a two-year bond rose above 11 percent, both
record highs since Greece
joined the eurozone. Particularly daunting is the
fact that short-term debt financing is now more expensive than long-term
funding. This situation is referred to as an “inverted yield curve,” and it is
generally considered a harbinger of financial doom. This means that investors are
sensing that Athens
is more likely to experience problems sooner rather than later.
Higher yields mean that Greece
is facing increasingly larger interest payments on an increasingly larger stock
of debt. This all but confirms that Athens’
claim that its stock of public debt will peak at 120 percent of gross domestic
product (GDP) is simply wishful thinking. Worse still, Greece is also facing continued economic
recession, induced in part by Athens’
austerity measures designed to reduce its budget deficit. Given this vicious
dynamic, we cannot see how Greece’s
debt level will stabilize at anything below 150 percent of GDP range.
The point is that the financial
writing is now on the proverbial wall; some form of default is simply
unavoidable. Exactly how the Greek default will unfold is unclear, but the
bottom line is that the question now is not “if” but “when.” Under “normal”
circumstances, when the IMF becomes involved with a country in a situation
similar to Greece’s,
the standard procedure is to devalue the local currency. By lowering the
relative prices within the economy, the devaluation increases the
competitiveness of the country’s export sector and helps to reorient the
economy toward external demand. Devaluation is also politically expedient because
regaining competitiveness does not require employers to slash employees’ wages,
as the devaluation adjusts the relative costs silently and discreetly.
However, Greece does not have the option of
devaluation because it is locked into monetary union. The eurozone’s
monetary policy is controlled by the Frankfurt-based European Central Bank. The
fact that Greece
is locked in the “euro straitjacket” raises two questions, the first being how
the Greek debt crisis will play out.
Without the option of devaluation,
the Greeks will have to implement and endure draconian austerity measures — in
addition to the ones it has already enacted — similar to what Latvia and Argentina endured as part of their
IMF programs. Argentina in
2000 and Latvia
in 2008 also could not go the currency devaluation route because neither
country controlled its monetary policy. In Argentina’ s case, the austerity
measures were so severe that they caused considerable social unrest — including
a brief period of outright anarchy in late 2001, which saw the country go
through five heads of government in about two weeks — ultimately culminating in
the country’s partial debt default in 2002. To this day, Argentina is
still dealing with the fallout of that financial calamity.
“Without the option of devaluation, the
Greeks will have to implement and endure draconian austerity measures — in
addition to the ones it has already enacted.”
Latvia is a case of more recent
vintage. In late 2008, Latvia
agreed to what the IMF itself has called one of the most severe austerity
programs since the 1970s. To accomplish it, Latvia has done everything from
slashing public sector wages by 25 to 40 percent, increasing taxes, reducing
unemployment and maternity benefits and cutting the defense budget. The crisis
has already cost the Latvian prime minister his job and stoked social unrest.
Despite all of that, the budget deficit has not budged much, remaining around
eight percent of the GDP mark. Spending has been cut to the bone, but Latvia is
simply too small of an economy to emerge from recession on its own. Since the
broader European economic recovery remains moribund at best, less government
spending has translated directly to less growth. Less growth means less tax
income, and less tax income means that the country’ s budget deficit remains
stubbornly high. Latvia
has essentially become a ward of the IMF, and will remain so until either the
broader European economic recovery is more robust or the Baltic state is
fast-tracked into the eurozone itself.
An EU-IMF bailout of Greece would ultimately give Athens
the choice of becoming either an Argentina
or a Latvia.
A financial assistance program that does not involve substantial structural
reform on Greece’s part
would lead to a default a la Argentina.
A bailout that forces Greece
to get serious about reforms would mean Greece
becomes an IMF-ward like Latvia,
with default still a serious possibility down the line. In either case, Greece
will essentially lose control over its destiny.
The next question is what the
rest of Europe will look like, and there is no
shortage of impacts. Europe, and Germany in particular, must decide
whether and to what extent it should “bail out” the Greeks. How that might
happen is now the topic of the day in Europe.
Driving the urgency is this simple fact: In the absence of substantial (and
subsidized) financial assistance, Greece will inevitably default on
its debts, thus generating write-downs for all those who hold Greek government
debt (mostly European banks). The Greek default therefore is no longer an isolated
problem, but a problem that threatens to aggravate an already weakened European
banking sector. One of the most misunderstood facts of the international
financial world is that even at the peak of
the U.S. subprime crisis, in the dark hours when American hedge funds
seemed to be snapping like matchsticks, Europe’s
banks were in even worse shape. As the Americans stabilized, so did their
banks. But Europe never cleaned house, and now
a Greek tsunami is poised to wash over the whole mess.