Greece Rescue = Smoke and Mirrors

It is astonishing that the words “rescue” and “bailout” are being applied to the headfake announced by the EU for Greece last week. Rebecca Wilder at Angry Bear blandly noted, “All I’m saying is that this plan, in its current form, is really not much of a plan at all.” Ed Harrison stressed that voters in Germany would be assured “This is not a bailout” (although he is of the school that anything to ward off speculators is a step in the right direction).

The big problem with this non-bailout bailout is that it appears designed to provide Greece with air cover so it can roll its debts coming due (April and May are crucial months) without adequately addressing the underlying problems. The problem is that deep budget cuts are almost certain to worsen rather than improve deficit to GDP ratio. They will simply put the economy into a deflationary tailspin, with the GDP contraction assured. Wilder explains:

Financial crises, especially those in small-open economies (Sweden, for example), generally end with a massive currency devaluation that drives export growth (provided there is external demand to suffice). I honestly don’t see how a sufficient export-generated rebound is even a possibility, given that the rest of the Eurozone is essentially trying the “internal devaluation” bit simultaneously (chart above).

And who’s going to pick up the slack? In 2008, 64% of Greece’s export income was derived by the EU 27 countries, 70% for Spain, and 74% for Portugal. If the Eurozone as a whole is using this same internal deflation mechanism to spur export growth, only the “zone” as a whole really benefits, not any one country.

WITHOUT a massive surge in export-driven GDP growth no “zone” country can drop its financial deficit without incurring behemoth debt burden growth (in the case of the Eurozone, the term “burden” actually applies since Greece, nor any one economy, can print its own money).

Yves here. The strategy appears to be kick the can down the road, get Greece through its near term financial needs and declare “Mission Accomplished.” But what does that achieve? If Greece has an unsustainable debt overhang, the best course of action is a restructuring (which amounts to a partial default), not roping more investors in simply to forestall the inevitable.

Wolfgang Munchau, whose initial reaction to the deal was skeptical, is even more critical upon further reflection:

The aspect that puzzled me most was the announcement that a rescue would come in the form of a loan at market interest rates. This surely must imply that the market would not be willing to lend money to Greece at market interest rates. That is an absurd proposition.

In fact, it is hard to imagine even a hypothetical scenario in which the European Union would disburse the emergency aid….

Judging from some of the comments from Greece, I suspect the big idea is to try to get by without help, using the promise of an emergency fund as a psychological support for the market. This is a dangerous confidence trick. It will backfire, perhaps not right away, but at some point. It was no surprise that Standard & Poor’s, the rating agency, concluded that its rating of Greek government debt would be unaffected by the deal….

When a country adopts an austerity package of such magnitude it needs some form of relief, simply to make it through the recession. This would normally come either through devaluation or from a low-interest loan, usually from the International Monetary Fund, or ideally both. Greece will have neither.

Under these circumstances there may come a point when the Greek government concludes that default is the financially superior option, especially since 70 per cent of Greek debt is held by foreigners. If they are smart, they will take the EU money and then default. In any case, default is still the true backstop, not the emergency loan. Bond market investors should be well aware of that…

I must admit that the late-night meetings, the dramatic announcement of an agreement, and the press conferences by European leaders are highly effective tools to impress the outside world. Ms Merkel in particular is a very persuasive politician. But the politics of smoke and mirrors cannot fool all the people all of the time. This will not end well.

Ambrose Evan-Pritchard savages the plan with his usual vigor:

The Frankfurter Allgemeine summed up the deal succinctly: “No member of Europe’s monetary union should be liable for the debts of another state. Bilateral credit from Berlin for Athens is not the same as German acceptance of responsibility for Greek debt.”

This shatters the assumption since Maastricht that monetary union leads inexorably to fiscal union. By drawing the IMF into Euroland’s affairs, Germany has broken the spell and reduced EMU to a fixed-exchange system with knobs on, like the 1930s Gold Standard that it so resembles….

The ‘rescue’ resolves nothing for Greece, either short-term or long-term…Greece is worse off than before. It cannot decide when to invoke the mechanism. It has given up its right as an IMF member to go to the fund when it wants, leaving it prisoner to Europe’s deflation dictates. “The IMF would be a lot softer than Europe,” said Ken Rogoff, the fund’s former chief economist….

Mr Nielsen said Greek data released last month show that the budget deficit is 16pc of GDP on a “cash basis”, rather than the official 12.7pc on an “accrual basis”. The IMF is watching closely, having warned last June that Greece’s “cash fiscal data show consistently weaker results than accrual data, which has been inadequately explained.” Translation: the real deficit is 16pc. Greece is drowning…Mr Nielsen said Greece would have to carry out an “internal devaluation of at least 20pc to 25pc” to claw back competitiveness lost over a decade. This means wage cuts…

I suspect that Greece has already gone beyond the point of no return with a public debt nearing 135pc of GDP by 2011 (Commission data). If so, the most likely way out is default within EMU. Athens can craft a “pre-emptive debt-restructuring” with the help of the IMF along the lines of Uruguay’s controlled default in 2003. But first we must go through the etiquette of exhausting all the options. “The game plan is to hope for miraculous growth,” said Mr Rogoff. Let us pray.

Yves here. The announcement does seem to have caught the hedgies on the back foot, but a tactical win is a far cry from a resolution.

Originally published at Naked Capitalism and reproduced here with the author’s permission.

2 Responses to "Greece Rescue = Smoke and Mirrors"

  1. RichardinDenver   March 29, 2010 at 8:22 pm

    Indeed, the most realistic and hopeful machinations in the intricate and clouded workings of this past week’s Greece Agreement is concisely pleaded by Ambrose Evan-Pritchard…”Let us pray.”

  2. Guest   March 30, 2010 at 4:24 am

    I agree that if the Greek authorities were responsible, they would be negotiating already a controlled default.Their slavish reliance on the EU is due their entitlement mentality that they can indefinitely live parasitically on EU transfer money or subsidized loans.No Greek politician is seriously interested in building a strong Greece. They see themselves as rent seekers and Greek voters as their serfs…..