13th April 2010 by Shaun Richards
Having had some more time to cogitate on the new rescue plan for Greece I have some further thoughts on it today. It is true that this plan does have more detail to it than the previous efforts but as I have thought about it some aspects of it continue to trouble me. Indeed my words from previous articles have come back to my mind so there are consistent themes here. For example we were promised more details on the role of the International Monetary Fund (IMF) and there is no sign of all of any conditions in return for the lending.
What would happen if Greece asked for the money today?
Here there are clear issues,say something happened today to plunge Greece into even more distress and she asked for the aid immediately. We hit an immediate flaw as the 30 billion Euros in bilateral loans from other Euro zone members would have to be approved in the parliaments in each of the Euro-zone’s member states before it could be paid out. How long this would take is unclear and imagine the problems if a parliament said no for example as Ireland did to the Lisbon Treaty. For those unsure about how the IMF would deal with this then it would negotiate with Greece over its lending to it and any loan would then be approved by the IMF board, and could then be given to Greece.
So if the money was asked for today it could not be given. The one organisation that could act fairly quickly the IMF has provided no detail at all on its plans. Europe could take weeks or more and there is no guarantee that every parliament would say yes. They would be under enormous pressure but as I pointed out earlier that has not always worked for the European Union. After two months of dithering we get a plan was is still somewhat unwieldy. I set some criteria for a successful plan back in an article on the 17th February.
1. That action needs to be quick and decisive. A decent plan operated quickly is preferable to a perfect plan that is dithered about.
2. Such talk will improve markets but like the boy who cried wolf it only has a limited lifespan. So politician’s who feel that talk is sufficient (and I am sure there are plenty of them) must be made to realise that talk without action is only a short-term palliative.
Reading it again it is clear to me that point one has still not been answered and needs further work. One of the lessons of this crisis has been that things settle down for a while but that markets sooner or later fret over flaws in official plans.
Can anybody go bust in the Euro zone?
This question and the apparent answer to it provided by the Euro zones response to the Greek crisis has clear implications. Taking the answer forward that no-one will be allowed to go bust has a clear implication for the countries in the Euro zone who have more prudent economic management and more favourable economic circumstances. You see if they feel that they are jointly liable for each others debts then why is Germany’s ten-year bund yield 3.1% and Greece’s ten-year government bond yield over 6 1/2%? A new Euro zone ten-year bond with an interest rate of say 4% would go down like a lead balloon in Germany and many of the other Northern European nations. It is an extreme example but illustrates the danger here.
Would another country get the same help?
In principle it should do but there are clear flaws here too. If we look at the likely candidates for help they are involved in the plan for Greece and accordingly are weakening their own position to take part. So if it is activated how would the Euro zone work out another rescue particularly as a possible candidate (Spain) is a much larger economy? The truth is that unless the next country to hit trouble is also relatively small it cannot.
No bail out clause
The Euro constitution had a clause stating that there would be no bail outs. This is a bail out and phrases from European Ministers at Sunday’s summit claiming that the interest rate on the plan is “non-concessional” are false.Markets have been wiling to loan money to Greece at around 6.5% before last week saw yields go even higher . Therefore an interest rate of 5% is at a subsidised rate when compared with market rates.When you consider that Europe’s taxpayers will be loaning money to Greece at a rate much cheaper than they, their banks or their pension funds are willing to then we may see this plan challenged in more courts that just Germany’s Constitutional Court.
What are the conditions?
So far there are none. This is simply not viable.
What will the IMF do?
Apart from vague promises and grandstanding we still do not know. As the IMF is the one organisation that could operate relatively quickly then this is a serious flaw that needs to be fixed immediately. It goes straight to my original point two for an action plan.
There is a lack of clarity in this area. As Mr. Kowalski commented yesterday on here there are elements of a three-year plan. However we only have any detail from the Euro zone ministers for a 12 month action plan with a three-year maturity. So what they will do in years two and three is undefined or to use their own words ” this has not yet been determined.” The IMF assuming it finally gets round to publishing some details will have to have more than a twelve month plan and 3 years is perfectly reasonable. So this area needs a lot more clarification as there is a clear mis-match.
I have been asked about the long-term solvency of Greece going forward and so let me explain what I think on this subject. There are various factors at play in such a situation.
a. She is in a severe austerity plan which intends to cut her public sector by the equivalent of 4% of GDP this year.There will be further cuts in future years.
b. Her national debt is already high in comparison with her GDP at around 114% and as even under her austerity plan she will still be borrowing substantially over the next 2/3 years this will deteriorate (rise) further.
c. Greece’s forecast going forward assume optimistic growth rates for her economy.
d. Sustained high yields on Greece’s government debt will mean that she has to replace cheaper debt with more expensive debt and she is also having to make a lot of new borrowing because of her high fiscal deficits. So she will be carrying an increasing deadweight going forward.
This is an area where Europe could have helped her by acting quickly as if you look forward from February this year then it was plain that most of her borrowing for this year would take place by the end of May, but now much of this has happened and to make matters worse for Greece she has had to pay high rates on it which she will have to pay until the bonds are redeemed/repaid. But it is now too late for much of this and is the reason for my cost of delay section yesterday.
To put this into numbers consider an interest rate of 6.5% on government debt and consider Greece’s position in 2012 when she will have a national debt of say 140% of GDP. This would mean that of her economic output some 9% would have to be spent on financing her debt. Now this is an extreme example as whilst Greece has plenty of new borrowing planned for 2011 and 20112 and many maturities she would still retain some cheaper debt but it does give an illustration of scale. Comparing with the UK at current levels and saying our national debt might be 85% of GDP in 2012 then using our bond yield of 4% gives 3.4% of economic output. These are back of the envelope calculations so please do not quote them with precision but they do illustrate the scale of Greece’s problem I feel.
So now looking at this as an overall position Greece will need to grow substantially to be able to pay for this. The problem is that her forecasts already assume decent growth. The next problem is that her austerity programme combined with increasing costs from her government debt are likely to make growth negative for next year as well as this. This is why I feel that she needs a debt restructuring to be negotiated as otherwise the numbers simply do not look like adding up as we go forward.
We have heard a lot of criticism of these during this crisis. However if you think about it probably the best opportunity to make easy money took place on Friday. As rumours circulated of a deal on Friday it seems clear that security was not as tight as it should have been,however those not in on the deal might have dismissed it quite reasonably on the grounds of another potential false dawn. This leads me to think that it is possible that some people may have had what is called an “early wire”. If you knew about the deal buying Greek government bonds on Friday was likely to be almost a risk-free and certainly highly profitable trade.
Such an action would of course be unfair on those trading without such knowledge. So I hope that the same Greek government which has recently imposed restrictions on those going short of Greek government bonds will cast its eye over those who bought them on Friday. Perhaps those who bought on Friday and sold on Monday might be a place to start. The credit derivatives that have recently been so criticised might be another. What is sauce for the goose is also sauce for the gander.
I am reminded of the words of a friend who once told me that he only thought insider trading had been made illegal because what he called the establishment had realised that they were no longer the only players in town.