Are we there yet?

June 20, 2011

FOREX, Global Macro

The Greek situation looks like it is going to get some sort of interim resolution but it remains fluid. We say interim because  the problems Greece faces remain intact – too much debt and too narrow a revenue base to pay it back sustainably, particularly with austerity, and the politics of the situation both in Greece specifically and more broadly in Europe remain fractured. But at least for markets it gives a reprieve to what was looking like almost certain default. But as I wrote in our weekly wrap Saturday

I’d argue, perhaps the glasses are rose-coloured, that the market performance this week was exceptional insofar as the excuse for dislocation and a crash was there but we only saw weakness and important levels held

Here is the link to the Weekly Wrap . We don’t get as much traffic on the weekend but it always ends up as our most read piece by the end of the week so we thought you might enjoy if you haven’t read it.

Writing in the FT over the weekend Wolfgang Munchau who has been one of the more prescient commentators on the European situation highlighted these tensions we mentioned above saying

Last week taught us something important about the political economy of the Eurozone.

There were two serious and overlapping crises. The first was a deteriorating dispute between Germany and the European Central Bank. It was about whether private investors should be forced to pay a contribution to the next loan programme for Greece. The dispute promised to derail the discussion for a follow-up loan, and could have forced Greece into a default. The second crisis was the near-collapse of the government of George Papandreou, Greek prime minister.

At the end of the week, Germany capitulated. And the Greek prime minister reshuffled his cabinet, ending up with more reformers in it than before.

So it was on Friday we received the news that the German and French Government’s had decided to drop their opposition to a voluntary “bail in” of investors holding Greek debt. How this would work in practice is problematic in the extreme but it does seem to have kept markets happier than they were.

Writing in Barrons over the weekend Alan Abelson summed up the situation beautifully when he said

“Under the “compromise” disclosed by Merkel and Sarkozy, creditors—mostly holders of endangered Greek bonds—would “voluntarily” participate in the bailout, which had been bitterly criticized by Germany and the European Central Bank; the latter already is on the hook for billions in Greek debt. Depending on private investors to voluntarily engage in the latest bailout strikes us as very much akin to asking volunteers to be guillotined. But we’ll see.”

My bolding obviously but isn’t that really the situation we are faced with at the moment?

It seems to me that this continues to be European procrastination in the extreme but in many ways the belligerence of the ECB in seemingly getting their way and so far avoiding a Greek default is truly the best thing for the globe at the moment. Certainly not the best thing for the Greek people who are going to have to suffer more austerity, hardship and unemployment and that is why the Prime Minister is struggle so hard to hold his coalition together.

So I’m guessing he wouldn’t have been too happy with news overnight that the compromise might once again be compromised with Bloomberg reporting that European Government’s might withhold half of the €12.2 billion in aid to be paid next month in order to wring more budget cuts and austerity. Bloomberg quotes the Belgian Finance Minister as saying this but that

“We will in any case try to release the necessary funds for the short-term”.

I certainly hope they do but this crisis is not one that is going to go away in a hurry. The challenges facing Greece remain large and with more protests in Athens last night it will be difficult for Prime Minister Papendreou to hold his coalition together. But Muchau makes a good point about Greek Default when he says

Even if a sensible programme were implemented in full, I doubt the Greeks would be able to pay back their debt in full. But why would they want to default right now? The state ran a primary deficit of 3.2 per cent of gross domestic product in 2010. Since then, public finances have deteriorated. Daniel Gros, director of the Brussels-based Centre for European Policy Studies, estimates the net borrowing requirement, on a cash flow basis, went up from 5.8 per cent of GDP in the period from January to May 2010 to 9.3 per cent in the same period this year. Greece is still some distance from a primary balance.

A premature default would cut the country off from EU-IMF aid, from international capital markets, and possibly also from ECB lending. It would lead to an immediate collapse of the state. The government would not be able to pay salaries and pensions.

The present austerity programme is mild by comparison. If you were Greek, opposed to austerity and rational, you would not default now. but comply until you reached primary balance and then default. But that will not happen until next year at the earliest, possibly 2013.

So markets, European politicians and the ECB all took us to the brink and back last week. Are we there yet? Not quite but it seems we are getting closer to some sort of resolution. Let’s hope so – but then we’ll be back to focussing on the global economy which is non to special either.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial adviser we are happy to help and if you are an adviser and would like to join our network we are also happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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