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Greek Option: NOT Growth vs Austerity

Posted by Larry Doyle on May 8, 2012 8:07 AM |

Growth vs austerity.

Who would not choose to increase economic growth as the path to future economic prosperity.

The election results in France and Greece over the weekend were a clear repudiation of the austerity packages negotiated earlier this year as the precursor for further German support and the European Central Bank’s LTRO (long term repo operation). That financing directed at European banks was little more than another version of the shell game that has been orchestrated by Bernanke and Geithner on this side of the pond. 

With the election results over the weekend and the social pressures sent along with them, the stakes are raised and the day of reckoning for the EU and the euro would seem to have been moved up. German Prime Minister Angela Merkel has been swift in stating that the austerity packages as negotiated must be upheld. Clearly the electorates in Greece and France and soon elsewhere as well have little appetite for those austerity measures. The pressure increases. The question begs, “who will pick up the EU’s enormous bill”?

To think that growth is easily accomplished is naive. Let’s not forget that the ratings agencies will be compelled to downgrade the sovereign credit rating of certain of these countries if they think they can increase deficit spending. Not that interest rates in the weaker EU nations are not already high but further downgrades would only push them higher. Higher rates do not exactly do a lot for those hoping for growth. The simple fact is, without the assistance of the European Central Bank and accompanying swap lines from the Federal Reserve, these countries would be capital starved as it is.

Will France, Greece, and other nations within the EU throw in the towel and look to nationalize some of their banking institutions and default on their bank debts in the process? No doubt the electorates in these nations look at that option as appealing. Screw the bondholders and their crony capitalist partners who plundered the nations finances over the last few decades. Seems all so easy, right? The waves from that tsunami would roll across derivatives markets and swamp many banking institutions around the globe. As such, central bankers are under enormous pressure to keep the zombie banks alive – – – at least in form and function.

What is behind door number 3 for certain nations, especially Greece?

Leave the euro and devalue a newly launched currency. Will it happen? What are the ramifications? Citigroup projects the chances of Greece taking this path at 75% within the next 18 months.

The stakes are raised. The standoff continues. The pressure within the EU cauldron is rising ever higher. At some point that pressure will boil over. Where and how it spills out will have enormous implications within the EU and the global economic landscape. However you slice it, though, economic uncertainty does little for economic growth in the EU and the world.

Bloomberg provides further insights on the chances and implications of a Greek exit from the euro in this 3-minute clip.

Those within central banks have been playing the “kick the can, we will pay you later” charade for the last 4 years. Well, “later” in Greece is now right around the corner.

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

  • LD : recommended

    Nice recap from David Malpass at Encima Global.

    The result of today’s European elections was at the low end of expectations.

    Greece’s traditional parties did poorly. Conservative New Democracy got less than 20% of the vote and socialist Pasok less than 14%, falling into third place behind a new leftist coalition party. The Greek president will give first place New Democracy three days to form a pro-compliance coalition government, which is unlikely. The president will then turn to the second place party to see if it can form a coalition pulling together the anti-compliance parties.

    Whatever the eventual coalition structure, we don’t think Greece will comply with its typically anti-growth IMF program (i.e. VAT tax increase, property tax imposed, large debt payments and continuation of big government.) One early test: under the austerity program, Greece’s government is supposed to lower the minimum wage in an effort to regain competitiveness and boost employment, but will have trouble carrying that out. We think Greece’s austerity program, especially in the first rounds, should have been applied mostly to the government itself including the large lifetime pensions for politicians, parliament’s staff, the Brussels’ staff, and government-owned assets.

    With a diminished chance of the third quarter EU/IMF disbursement, we expect the Greek government to run short of cash because: 1) the election results will further depress tax payments, causing a near-term deterioration in Greece’s still-large fiscal deficit; and 2) the results discourage making investments in Greece and holding bank deposits there, increasing the flow of euros from Greece to German and Swiss banks and into euro paper money. The action-forcing-event is how long Germany, the Bundesbank and the ECB continue to allow Greece to fund its cash shortfall by hollowing out the remaining assets of its commercial banks and the Bank of Greece. (The fragile euro-system forbearance process is discussed in our previous pieces and relates to under-collateralization, ELAs, target 2 imbalances, the ability of banks to operate with declining or negative net worth, etc.) Complicating the issue, the election results included 20 neo-nazis among the 300 Greek parliamentarians.

    In France, President-elect Francois Hollande won 52% to 48%. We think the fiscal pact will proceed toward ratification, but Europe will now begin work to add an undefined “growth compact,” causing more summits, delays and policy uncertainty. The growth pact might involve more funding for the European Investment Bank and more pressure for an EU-wide financial transactions tax with the proceeds spent on government investments. We think Germany will try to work with France’s new government, pushing the UK further to the outside. We don’t expect ECB bond buying or EU joint liabilities to come out of the growth discussions (see discussion of Germany’s election below).

    Regarding France’s domestic policy, Hollande will probably get a honeymoon from voters, though whether he gets much of one from bond markets depends on his opening policy statements. Hollande displays an attractive personal frugality and has promised to lower his own salary and other government wages. This would be a symbolic plus if he can carry it out quickly. We think austerity for the government is pro-growth whereas the impact of austerity imposed on the private sector during a slowdown depends on the details.

    Holland’s growth program probably can’t add much to the government’s direct spending given the growing fiscal deficit and widening bond spread. Instead, we expect more mandates on the private sector in an effort to force increased investment and hiring. If aggressive with this, we think it would have the opposite effect, pushing France more quickly into a double dip recession (joining the UK and Spain.) In addition to advocating a 75% millionaire’s tax, Hollande has advocated an extra corporate tax on un-reinvested profits (i.e. dividends and excess retained earnings) as a way to force corporations to invest more in France.

    One unknown is how the French election will affect structural adjustment programs in the periphery. Hollande has criticized austerity. This may influence the relationship between the troika (IMF, ECB, EU) that evaluates structural reforms and the governments of Ireland, Portugal and Greece. In Italy and Spain, the new French viewpoint might undermine and give justification for keeping big governments. If so, it could widen bond spreads and accelerate credit downgrades.

    The most important long-term issue is whether the change in Europe’s political direction ends up undercutting Europe’s clear resolve to keep all 17 countries in the euro until the broad crisis is over. We think Europe could someday develop an orderly, legal, voluntary exit strategy for say Greece, but not until credit spreads in the other 16 are much narrower. If social and economic conditions in Greece deteriorate to the point of a disorderly departure from the euro, we think it has very negative implications for the periphery and the global outlook.

    Germany held a state election in Schleswig-Holstein today. The election result will swing the state government from CDU to a likely CDU-SPD coalition. The Christian Democratic CDU took 30.5%, Social Democratic SPD roughly 29.5%, a much-diminished FDP 8.3% and the new Pirates party 8.2% (it advocates internet privacy and freedom).

    Even so, we think Chancellor Merkel, whose popularity is higher than her CDU party’s, a rarity, will have substantial control of debt policy through the November 2013 elections. Her views will probably hold sway on European policies on structural reforms, greater official resources, EU joint liabilities (i.e. EU bonds, euro-zone bonds, euro-zone bills, EU guarantees of sovereign debts) and even the tolerance of the ECB and Bundesbank for euro-system imbalances and under-collateralization. We don’t think Merkel’s views will change based on today’s elections, but will instead evolve with developments. Greece’s election poses immediate problems, while France’s creates a longer-term challenge to the euro-zone’s policy direction.






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