I've just agreed to write a quick book for Wiley and the Bloomberg Press about Greece, the euro and the sovereign debt crisus. More about that later. In the meantime, my latest column for Money Week is about just that.....here's a taster.
The debate about whether Greece can survive in the euro is getting more surreal with every week that passes. The leaders of the European Union and the European Central Bank are still insisting that a Greek default on it debts is impossible. It doesn’t even need to be thought about.
But a glance at the price of Greek debt, and the cost of insuring it against default, tells you something very different. The country isn’t going to be paying back the money it owes – not in full, anyway.
There are almost certainly going to be defaults sooner or later. The problem is, the bland, myopic assurance from European finance ministers that it can’t even be contemplated is only going to make the crisis worse.
It is time, they stopped burying their heads in the sand, and started figuring out how to cope with the consequences of Greece going bust.
The degree to which central bankers and politicians are still in denial is neatly illustrated by the fiasco of the ‘stress tests’ that are currently being carried out on Europe’s major banks. At an EU summit last month, the German Chancellor Angela Merkel and the French President Nicolas Sarkozy cooked up the wheeze of testing the ability of the continent’s main banks to withstand whatever economic storms might get thrown their way.
It was not, in principle, a bad idea.
The markets have been speculating feverishly for months over the possibility of huge losses on dealings in Greek, Spanish or Portuguese government debt lurking somewhere within the banking system. The tests will probe the soundness of each bank, look at how it might stand up to different shocks, decide whether it has enough capital to pull through, and recommend if it needs to find some more cash from somewhere.
That, surely, will reassure the markets?
Well, probably not? Why? Because the possibility of a Greek default will not be among the scenarios under consideration.
According Jose Manuel Gonzalez-Paramo, the Spanish board member on the ECB, the regulators don’t need to test the scenario of a sovereign default by one of the euro zone countries. Why not? Because the idea is “absurd”, apparently. “ The euro cannot allow a default and therefore there’s nonsense doing a stress test based on that,” Gonzalez-Paramo said last weekend.
That is, to use his own phrase, ‘absurd’. The possibility of a default is the one thing that the markets are really worried about. It’s a bit like BP saying it has run though all the possible future scenarios it might face, and costed them fully – but it has ignored the ‘absurd’ possibility that it won’t be able to cap the oil currently spilling out of its well in the Gulf of Mexico.
A Greek default is precisely what the EU should be worrying about. Greek government bonds currently yield 10.2%. That is more than four times the 2.5% yield on German government debt. If both Greek and German government bonds are rock-solid investments, on which there is zero possibility of default, how come the German bond is four times as valuable as the Greek one? Simple. You’ll almost certainly get your money back if you buy the German bond, but if you buy the Greek one you probably won’t. Indeed, a survey released this week by CMA DataVision concluded that Greek debt was now the second riskiest in the world. Venezuela was still a worse bet. But Iceland, Egypt and Romania, those paragons of fiscal rectitude, had all pulled ahead.
It is nonsense to pretend that there can’t be a default by a euro nation. Greece is stuck in a deflationary trap, from which there is unlikely to be any possibility of escape unless it restructures its debts, or devalues its currency, or quite possibly both. Even if the austerity programme for Greece agreed with the EU and the International Monetary Fund works, and there is not much sign that it will, Greek debt will still rise to 139% of GDP by next year, according to calculations by the Bank for International Settlements. The debt burden just keeps on growing, the capital markets remain closed to the country, and sooner or later the interest payments are going to become unsustainable.
And yet, the EU and the ECB are sticking to the line that Greece will be just fine, and the euro will look in great shape once the markets calm down.
That is the wrong way around. Instead, they should be planning for an orderly, managed default by the Greeks, and possibly the Spanish and the Portuguese as well.
In truth, a default need not be catastrophic. A decade ago, Russia defaulted on its debts, but came back quickly. Thailand effectively defaulted on its debts during the 1997 Asian financial crisis by devaluing it currency sharply. But a decade later the Asian countries, including Thailand, are all growing strongly again.
But it is far better if the default is managed and controlled.
There are two big problems that need to be addressed if Greece goes bust.
First, the European banks have huge exposure to Greek debts, as well as the rest of the highly-indebted euro zone countries. Between then, French and German banks have an estimated $1 trillion in paper issued by Greece, Spain, Portugal and Ireland. If that suddenly has to be written down to nothing, it could trigger a wave of banking collapse right across the continent.
Next, the cost of borrowing for Spain and Portugal, and possibly Ireland and Italy as well, could soar as investors start worrying they would be next. If they were locked out of the capital markets, it could make default inevitable.
But both problems can be addressed easily enough. Make sure there is enough support for the banks to make sure there are no collapses. Next, make sure there is money available to fund the Portuguese and Spanish deficits until the markets get back to normal.
It is far better to deal with problems early and decisively. Just denying that Greece could ever default is not doing anyone any good --- it almost certainly will, and the sooner the EU owns up to that, and start planning for the fall-out, the better.