Europe’s Debt Crisis: The Fires Behind Smoke and Mirrors

First, before we go any further please cast your minds back to this blog exactly a year ago and we ask you to reread THIS posted on 10th May 2010.

It was to the day that the markets were responding positively to announcements of European rescue packages designed to support the ailing periphery whilst they implemented austerity measures designed to cut their internal debts to levels that made it serviceable in the long run. And to wit, MM commented at the time:

As always in the Eurozone, conditionality and enforcement are paramount issues that will be tricky to solve. No doubt Portugal, Spain, et al. will say the right things and appear to toe the line…but what happens when growth undershoots and so do fiscal revenues? Which will give way…living standards for civil servants, or fiscal rectitude? (This, as an aside, is the primary argument for IMF involvement: so the German’s won’t have to play “bad cop”).

Now we have always known that it has been a tightrope for the peripheral Governments to walk. Not enough talk of implementing austerity and the desperately needed emergency funding will not be forthcoming… No actual austerity and there will be no improvement in debt burden and no long term solution. Against which, too much austerity will see a public backlash which could kick out the Government and result in economic mob rule (as has happened in Iceland where public referenda are used to decide whether international debt should be repaid; result is Ms Dottirdottir saying “Nei”).

For the past year the Greek government has been playing the population off against the European creditors. But just as a teenager will promise his mum he has stopped smoking in order to collect the $100 promised for doing so, while just sucking on mints to cover the smell, Greece hasn’t stopped the rot at all and the wafts of peppermint no longer shroud the stink of smoke from the utterly horrendous data out recently from Greece (Nominal GDP -2.1% vs 5%+ financing rates, Real GDP -6%). TMM’s suspicions and concerns from last August in their “Postcard from Greece” now appear fully justified.

So the European debt collectors have started knocking on the door but have arrived to be greeted by a debtor threatening to trigger the suicide belt of leaving the Euro, causing collateral damage that threatens the very foudantions of the building. Recent comments have TMM’s nostrils twitching to the smoke coming from a bushfire:

1. (The above mentioned Greek data is utterly horrendous.
2. Bini-Smaghi and Nowotny suddenly are not sounding like central bankers anymore, very odd – almost “panicked”.
3. The Friday meetings was with the big guys alone, and were vehemently denied even as they happened – seems like desperation.
4. Continued dialogue from respected economists and politicians about how such austerity has never been unaccompanied by debt forgiveness.
5. Discussions by ratings agencies and bank economics departments that maturity extension alone is insufficient to regain fiscal solvency.

TMM have thought hard about the current strategy of increasing aid and extending maturities and now think there is an increasing probability that the Eurostriches are finally recognising we are on the following path that ends with “Lions”.

1. EU institutions keep rolling over Greek loans and extending maturities.
2. Private debt stock gets gradually paid down.
3. EU institutions end up holding a very large amount of outstanding Greek debt stock.
4. Greece is unable to get any or all of (i) enough Growth, (ii) enough tax collection, (iii) enough spending cuts etc.
5. EU institutions are forced to take a large haircut on the debt stock.
6. Political crisis of the EU when it becomes clear that the EU has to take a hit of EUR150-200bn (to put this into perspective, the EU budget is EUR133bn…).

That doesn’t only threaten the existence of the EMU, it could ignite the EU. TMM are seriously worried that the Eurocrats have moved into the depression stage of grief over the loss of their investments, both financial and political, in their Euro project and it will not take long to move from the depression stage of grief to the “acceptance” stage. We – like many now – feel that a new Greek package that includes an agreement on private participation is coming soon as it will be easier, politically (not just domestically, but also in terms of “The European Project”), for France and Germany to justify bailing out their own banks directly (blaming Greece) rather than justify bailing out Greece directly again for another year.