Friday, May 25, 2012

Greece: Containing the contagion.

Is Europe kicking the can down the road to another global meltdown?

It’s amazing how often, when you strip economics from its jargon and pseudo-complexities, you end up with the wisdom of ages, simple logic and basic rules of good housekeeping. Indeed, “good-housekeeping” I’ve been told, translates into “economides” in Greek, from which the word “economics” has been derived. That’s surely irony above all ironies. Equally amazing is how often these rules get ignored, mostly by the practitioners of the jargon and pseudo-complexities.

The current Greek crisis illustrates the point. A 19th century aphorism that says: “You cannot strengthen the weak by weakening the strong” is a very apt description of what’s happening in Europe. For more than 30 months now, a crushingly debt ridden Greece has been propped up by bailouts from other members of the euro-zone, the European Central Bank and the International Monetary Fund to the tune of 250bn euros, with the Financial Times reporting this week that a further 100bn has been advanced through a covert ECB facility. In turn, all eyes are on big brother Germany, which is the only big economy strong enough to hold the euro-zone together. With its own history of post war deprivation, Germany has insisted on stringent austerity measures for Greece.

The Greek’s are clearly baulking. They have been in a 5 year recession, hardship for the population is increasing daily, the government debt is simply too burdensome, the fiscal measures too severe, and political leadership too fractured and indecisive. Greece, according to New York economist Nouriel Roubini, is “stuck in a vicious cycle of insolvency, lost competitiveness, external deficits and ever-deepening depression”. So Roubini and many other commentators are increasingly feeding the financial news headlines with the inevitably of a Greek exit (Grexit) from the euro-zone – within days, some say.

This has been fuelled by euro-zone officials on Wednesday advising members to prepare contingency plans in case Greece decides to quit the bloc. So far, the majority of Greeks have shown a preference for staying in the zone, but have rejected the bail-out conditions.

But there are still those who believe the fears of an immediate exit are overblown. After all, they say, we have been through this all before, with the same brinkmanship being displayed and with Greece not being able to fully meet its commitments, but still being advanced further bailouts. Already, German Chancellor Angela Merkel appears to have been influenced by some badgering from key European partners and other G8 Economies all favouring a growth friendly approach. “Maybe our rhetoric (on austerity) has been too dogmatic”, said Nick Clegg, British Deputy prime Minister.

How is it possible that a member country, representing only about 2% of the economy of the euro-zone, can hold such sway on the rest? The answer is to be partly found in another bit of ancient logic: “If you owe the bank a million bucks and you can’t pay, you are in trouble. But if you owe the bank a billion bucks and you can’t pay, the bank is in trouble!”

But, as Felicity Duncan pointed out in her article on Moneyweb this week, the implications go further than avoiding throwing good money after bad. A Greek exit will plunge Europe deeper into recession and countries such as South Africa, with Europe being our largest trading region, will feel the effects. But then, at least we have art to distract us!

Not so the Reserve Bank’s monetary policy committee, which is clearly very concerned and spent a large part of its meeting this week on discussing the implications of a euro-zone fallout. It could leave the Bank with a policy conundrum in the wake of capital leaving emerging markets for “safer-havens”, downward pressure on the Rand, and lower growth prospects. It then has to juggle between higher interest rates to counter inflationary pressure or lower rates to encourage growth.

Despite German Central bank assurances that a Greek exit would be “manageable”, there are fears that the contagion could go much wider with the possibility of an eventual implosion of the euro-zone and in turn a global financial meltdown similar to, if not worse than 2008. Apart from the agonising financial burden of European and other institutions holding worthless Greek paper, what has started as a “bank jog” in Greece with private interests withdrawing their euros from banks in case they had to convert to drachma’s, could spread to banks in other euro-zone countries such as Italy and Spain. Together they make up 28% of the euro-zone economy and there’s not enough money in the EU bailout fund to prop them up.

The United States, as a major Western economic force, will not be immune. It may not be significantly exposed to Greek sovereign debt (less than $6bn) but it’s exposure to countries such as Spain, Ireland, Italy and Portugal amounts to just under $130bn. European holdings represent 35% of the assets of prime U.S. money market funds. Then there’s trade with Europe that makes up 13% of American exports and losses for American companies operating in Europe. In short, a threat to European welfare poses a significant threat to America’s hesitant 2.2% economic growth. China too, could have a further chilling of its already cooling economy.

One also cannot ignore other risks -- such as civil unrest in Greece itself that could destabilise the whole region, the threat of escalating xenophobia in Europe, and of course, jittery speculation-driven world markets that have an enormous propensity to over-react and exaggerate underlying problems to become self-fulfilling prophecies.

While many of the fears about a Greek exit from the euro-zone may be hypothetical, they do, at this stage, appear to preclude a sudden and disorderly departure from the euro-zone. The European preference for growth rather than fiscal and monetary austerity, also favours a compromising approach to Greece. Next month will be critical as the Greeks vote for a new government, debt repayments fall due, and the government starts running out of money.

In the longer run, saying goodbye to Greece is not unlikely. Nouriel Roubini believes it is essential, and the sooner the better. Though painful, the contagion, he believes can be contained by a well-managed and sensibly financed process. “Like a doomed marriage, it is better to have rules for the inevitable divorce to make the split less costly.”

It’s only when we see Greece in the wider context of a global economic malaise and how we got there, that we can appreciate its significance. The western world had two choices after 2008 which followed decades of financial excesses and recklessness: it could accept a period of severe austerity to blow off the froth of speculative non tangible wealth, or it could go deeper into debt to “economically grow” out of its problems. It chose the latter. Until that course proves to have been the correct one, we will continue to live in a rather insecure world with its sporadic Greek tragedies.

Then another bit of old world logic comes to mind: no matter how many credit cards you have, you can never borrow to get out of debt.

Or, as Boetcker put it more than a century ago: “You cannot establish sound security on borrowed money”.

1 comment:

  1. Euro Zone does not have to worry even if Greece will separate from them, because, the United States will take Greece's place in the Euro Zone.

    By: exchange rates