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Athens Agony, Lisbon Lethargy; Euro Zone In Crisis

Saturday May 21st 2011

Yesterday saw the Greek credit rating cut  3 levels by Fitch to B+ and left the struggling sovereign on a negative outlook. The rating agency said in a statement that even a voluntary restructuring of the country’s debt being considered by European Union (EU), policy makers would be ruled a default.           
At last some common sense has been spoken. If an individual, corporation or indeed a nation borrows money and signs up to an agreed repayment rate and date; any breech of that is, in anyone’s language a default.
Fitch is the 2nd rating agency to take such radical action; recognizing that last May when a rescue package was thrashed out it was built upon 3 pillars of strength.
1) Reducing the fiscal deficit by rolling back the state
2) Making appropriate interest/coupon payments
3) Paying in a timely manner all future monies due on reaching maturity
It was only 3 weeks ago that the IMF Chief Economist, Olivier Blanchard said that Greece was paying too high a rate on its debt and facing too short a repayment period. This is coupled with the comment from the IMF Athens Mission Chief that Greece had no choice but to pick up the pace of economic reform. Poul Thomsen said:
“…The view seems to be taking hold that the government programme is not working…the programme will not remain on track without a determined reinvigoration of structural reforms in the coming months.  …”
One would feel compelled to conclude that whichever optic one chose to look at the Greek economy with, the 3 pillars are showing severe signs of structural fatigue and are crumbling before our eyes. That is why investors have shunned Greek debt to the extent that the 10 year Greek Government bond closed on May 20th 2011 at a yield of 16.73%, which is a spread of 13.66% or 1366 basis points over German 10 year paper. At the end of 2010 the Greek 10 year yield was 12.44%, at a spread of 951 basis points…those days seem a long off now.
The International Monetary Fund (IMF), an institution with serious leadership matters on its mind at the moment has, in the case of Greece, suggested that for 2011 the economy as measured by output, i.e.  GDP will contract by 3.0%. As the government lags behind the pace of debt reduction the level of the fiscal deficit to GDP will stay at 10.0% and not the required 7.4%. Of course the soft terms of recent €110Bn bailout loans are detached from whatever refinancing rate the European Central Bank (ECB) choose to set, although the rush to raise Euro Zone rates will be a fetter to the Greek economy. Unemployment is stuck at 15.1%, a record high; unless the government introduce a set of economic policies that will support and not suffocate the private sector and stand by the shoulder of the entrepreneur and not ride on their backs then the Greek youth have a dismal future to forward to. The lack of steady tax receivables and a socialist agenda that is still pursued from Athens implies that it is almost impossible for the creative energy of the free market to be unleashed. Greece is a nation that has tinkered with the socialist ideal and sought to redistribute wealth from the haves to the have nots. The trouble is that socialism is a wonderful idea until someone has to pay for it. No society can keep bleeding the creative classes and expect to keep coming back for more.
This past week has seen IMF and EU delegates go through the national books in Athens;  it is clear Greece cannot meet it debt servicing and repayment costs. European ministers have been negotiating at a furious pace as they strive to find a method that will prevent Greece from defaulting. That course of action has been described by officials as a catastrophe; not only would it cause a run on the Euro, it would create a blowout in spreads to say 2000 basis points over Bunds and the capital of Greek banks would be largely if not entirely be wiped out. 
The ECB has already threatened to stop accepting Greek Government Bonds as collateral for cheap cash at the discount window. What on earth are those banks awash with Greek IOU’s going to do? The Chief Economist at the ECB, Jurgen Stark, has stated that if Greece were to reschedule/restructure the terms on its obligations it would strip any shred of liquidity and security value away from Greek paper. However, the ECB is trying to deflect attention; it is clearly looking at its own portfolio that holds €50Bn of Greek debt on the books. That is one serious driver behind the decline in the €/$ rate this week. The ECB under its constitution was never meant to accept low grade dubious quality paper as collateral, even if a hefty haircut were taken. Now we see the folly of having diluted the asset book. Sure, the scheme of ECB finances, €50Bn is not huge, however, this is where the so called superior way of handling the regions financial crisis as against the Fed’s Quantitative Easing programme has to be called into question.  Some say the ECB are just blowing off steam and that they will have to continue taking the Greek paper or risk pushing Greek banks over the edge. It may not be carved into stone anymore as to what credit rating paper must carry; indeed it may be a discretionary matter. Right now the ECB had better be realistic and recognize that biting the bullet now will be less painful than doing it later when the exposure runs at €75Bn.
We say this because if deficits are allowed to run, year after year in an out of control manner then they will cause a variety of problems for the nation. Clearly Greece has left the Drachma behind, however, the Euro does weaken to some degree and of course Greek debt is sold aggressively in the markets. At some stage certain investors may feel there is a sufficient premium for them to accept the distressed debt…in this case though, there a grave concerns as to the ability of Greece to make good on even rescheduled obligations…in short the debt becomes offered only. The long term consequences are severe as a high fiscal deficit is deferred taxation from future years. Debt when used to build infrastructure or to create a pool of funding for the future is not such a bad thing. When, it is borrowing in 2011 to repay borrowing agreements entered into 5 or 10 years ago, markets question what will be used to repay the debt acquired in 2011?
Poul Thomsen has insisted that Athens take the steps necessary to allow market forces and the private sector the scope to become more directly involved in the transformation of the Greek economy. He has rightly pointed out that higher taxation is not the way ahead.
We wholeheartedly agree, however, in my “Postcard from Greece” written just under 12 months ago I showed how the tax take is being shortchanged. Rather than use the legally required cash register that creates a paper trail to allow the correct tax to be levied, many transactions are handled by money in and out of a shoe box. No paper records therefore no tax to pay…why it even pays to offer a cash discount.
One cannot be unsympathetic to the Greek nation for what is the chance of growth when the Euro Zone powerhouse Germany will splutter this year.  The Bundesbank said Europe’s largest economy will lose growth momentum over the coming months. Germany’s economy has driven the Euro Zone after expanding a record 3.6% in 2010. Companies have filled the space vacated by the government and are ramping up spending and hiring to meet booming export orders, while unemployment at a 19-year-low should encourage private sector consumption. Hmm, not if the Bundesbank keep making such mournful forecasts, the specter of a slowdown and limited job hiring, or even redundancies will simply stifle domestic demand.
Greece was not the only distressed Euro Zone nation to be in the news this week.  Portugal has to pay a market rate of 10.70% for its 10 year paper with a spread of   764 basis points over the German core …it was 363 basis points as 2011 began.  Today the IMF signaled approval for a 3 year €26Bn loan as part of a joint bailout with the EU in the latest effort to stem the Portuguese sovereign debt crisis. The IMF will make €6.1Bn available immediately, the fund said in an e-mailed statement on Friday, May 20th. The IMF followed European officials, who on May 16th signed off on the €78Bn joint package.
Acting Managing Director John Lipsky said:
 “…The Portuguese authorities have put forward a program that is economically   well balanced and has growth and job creation at its centre…It addresses the fundamental problem in Portugal – low growth – with a policy mix based on restoring competitiveness through structural reforms, ensuring a balanced fiscal consolidation path, and stabilizing the financial sector. …”
The financing package is designed to afford Portugal a degree of restbite from the difficulty of raising capital in the commercial market. However, can it show a genuine desire to take the required policy steps that would put the economy back on a more even keel?  Somehow we think not and remain highly dubious. Portugal will get limited mention as the spotlight is firmly on Greece. It is, however, a powder keg with long, but lit fuse.
As the week closed out so the Stoxx Europe 600 Index receded 0.3% to 279.65 this week. Greece’s ASE Index dropped 4.3% to a 14-year low, the largest fall among 18 western European benchmarks, as the nation’s 10-year bond yields soared to yet another record.

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