It ought to be Rule No. 1 for any effort to fix a financial crisis: Don’t do it during an election. Politicians pandering to voters are likely to make a bad situation worse.
Which unfortunately is exactly what’s happening in the current Greek debt crisis.
The German government of Angela Merkel faces a tough May 9 state election in North Rhine-Westphalia, Germany’s most populous state, that could force coalition partner the Free Democrats to campaign against the plan for a $60 billion Greek rescue co-financed by the IMF (International Monetary Union) and the members of the European Union. Germany would pick up the biggest share of the tab in any such rescue plan.
Opinion polls show that 86% of Germans oppose the bailout plan. And with support for the Free Democrats at just 6% to 8% in recent polls, the party faces an almost irresistible temptation to bash the plan. Especially because the opposition Social Democrats have ratcheted up their criticism of the plan.
That has left Merkel’s government, a coalition between her Christian Democratic Union and the Free Democrats, doing some tough talking that threatens to make the bailout plan into a recipe for disaster in Greece. Merkel said just today, April 26, that she won’t release any funds until Greece shows that it has a credible plan to cut its budget deficit not just in 2010 but in 2011 and 2012.
The Greek government has already introduced increases in the national value added tax, cut public sector jobs, wages, and benefits, and pushed to cut private sector wages as well in an effort to reduce a 2009 deficit projected at 12.9% of GDP to below 9% in 2010.
Merkel is now asking for detailed plans that would cut the deficit by another three to four percentage points of GDP in each of 2010 and 2011.
There are three things that can happen here. None of them good.
- The parties squabble and Greece misses its May 19 deadline for re-financing $11.3 billion in Greek bonds that come due then. That would force some kind of debt moratorium that could destroy any hope that Greece can access international financial markets to finance its deficit. Bankers working on the deal say that something needs to be in place by May 6 to meet the actual May 19 re-financing deadline.
- Germany gets its way, the Greek government delivers the kind of detailed austerity program that Merkel is insisting on, and then collapses. Greek Prime Minister George Papandreou has been trying to avoid spelling out the worst parts of the solution to avoid making his own political crisis worse. The austerity measures identified so far are deeply unpopular in Greece and opposition parties have joined to try to kill the plan. The collapse of the Papandreou government might mean that Merkel got what she wanted on paper but that the effort killed the only Greek government that could possibly deliver those promises. The IMF and the European Union would then be faced with a new government determined to negotiate better terms. I think this leads to either a collapse of the bailout plan or a political crisis in Athens or maybe both. Bet the financial markets would really like that: A crisis with no one in charge or with the power to make a deal that’s not likely to last longer than it takes the ink on the document to dry anyway.
- The Papandreou government manages to give Merkel enough of what she wants so that the bailout plan goes through—and the government somehow clings to power. I think this only puts off the day of reckoning. The only way that Greece can escape a future where a round of budget cuts slows the economy, lowering taxes and increasing the deficit, which requires another round of budget cuts, which slows growth even more is if the Greek and European economies grow fast enough to increase Greek GDP. Greek growth isn’t likely under the kinds of cuts proposed by Merkel. European growth is projected at just 1%to 2% in the period that counts. And with the current imbalances in the European Union—Germany grows its economy by exporting but its frugal consumers don’t spend very much—it’s pretty clear that 1% to 2% growth in the European Union as a whole isn’t enough to let Greece dig out of its hole.
Greek interest rates, already 6.07 percentage points higher for Greek 10-year bonds than for equivalent German maturities, are headed higher, and the euro is headed lower against the U.S. dollar. The only questions are how fast and how short the temporary bounce from the final delivery of any bailout funds might be.
zak,
That is the true question, isn’t it?
By itself, Greece really does not have much of an impact. Combined with the rest of the PIIGS in the EU, that bodes poorly for the future of the EU.
If the EU breaks up, the period of instability that follows a breakup would be a problem for world trade (and by extension, the U.S.), since the EU is arguably the world’s largest trader. This is the worst case scenario.
If the EU shrinks, dropping several of the PIIGS, that could actually turn out to be a good thing for the euro in the long term, although you’d still see a period of instability while they work out the kinks.
If the EU stays together, expect the value of the euro to drop, since they will have to inflate the euro in order to handle all the PIIGS debts. This could be good for EU exports (Hooray for cheap imported German beer!), but bad for U.S. exporters to Europe. I would also expect to see some new EU agreements in place to prevent this kind of occurrence in the future (I guaranty Germany will demand it).
milan.sczuka,
I can’t speak for the free floating European currencies, but gold is a safe play.
I wouldn’t bother with the dollar. While it will rise against the euro, it will fall against other world currencies, such as the Brazilian real and the Chinese yuan (once they revalue it).
Default is not the road to prosperity.
Well, I guess we can’t be too snooty about it being unwise to lend to those lazy socialist Greeks since, as I understand it, the United States is bankrupt under any calm, ordinary way of accounting. But, hey, the game goes on.
This blew my mind: John Williams, an economist at Shadow Government Statistics says that using stats aligned with Generally Accepted Accounting Principles (GAAP) that the US has published, the government had about an $8.8 trillion deficit in 2009, when you include all the real stuff like Social Security & Medicare payments. He says that means if you taxed 100% of every company’s and every person’s income in the country, it still wouldn’t cover our annual deficit. Or if you could cut out *all* government spending except social security and medicare, we’d still be running in deficit. I haven’t done the math myself, but I have the impression that he does pretty good work over there. Also, as most people know, the US government and private total debt curve is in the vertical phase of a multi-decade exponential chart. Not good. These are concerning things that won’t matter until they do – which, of course, could be anytime – but most likely, won’t be before Goldman and JP Morgan have had time to get their massive bond short positions in place. We’ll keep an eye on them 😉
So, we might as well at least act friendly toward the Greeks, even if we don’t help much. Maybe they’ll have a kind word or help clean up when it’s our turn to fall out of the sky.
Jim,
I am a european living part time in Poland, part time in Czech Republic. If there is a default or its real danger, EUR is going to depreciate, What about central european currencies like zloty, czech crown, forint which are free floating? Would it be better to convert to USD, buy gold….? Thanks for your insight.
i
If Greeks default what will be the impact on US and global markets?
If I were German, I would never give money to Greece. It is a bad investment.
On the other hand, talk is cheap. Germany can say whatever they want, but at the end of the day, they will pull money out of their pockets to save Greece.
@Purewater… I think the point is taxes have to be raised or at least held while cutting spending, which will be a killer absent growth. I doubt there’s any way Greece can pull off cutting taxes and spending even further at this point. It’s hard to lay everyone off when there’s no work.
I agree with you though. Default and get it over with. Let the reward takers deal with the risk and not the German people.
Ben, Good point…that’s a major reason why Panama, Colombia, Uruguay and Chile are all booming. Kicking the can down the road won’t work. Default and restructure does.
the world is a very pragmatic place, every nation puts its own interests above all else. some liberals in the US still believes that international organizations and institutions can help resolve individual nations’ domestic issues, but so far the EU and UN are powerless when countries like Germany takes self-interests over internationalist ideals. After Greece comes Portugal, Spain, Ireland….. This is going to be the beginning of the end for the EU and the Euro. Long live the US Dollar!!!
Jim, So what is the timing of this hitting the market. Sounds like it may be coming sooner than later… Do you suggest taking some profits now, before the market correction happens. Or do you suggest waiting for the correction and then buying in after it starts coming back again?
Purewater,
that’s worked well throughout south/central America over the years…….
Jim, I think you and most of the other pundits have this exactly backward. Severely reducing the size/scope of the Greek gov’t, privatizing industry & reducing tax rates is the only way that their economy is going to transform itself into a growing and vibrant economy. Personally, I think they should default on the debt as well to give them a fresh start; that has the added benefit of punishing anyone stupid enough to loan money to a Socialist government.
86% of Germans against bailout Greece? I told you so. The Germans have no love for the Greeks, nor they like other southern and eastern neighbors.