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Greeks might pull plug rather than play hardball with Merkel

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Greece’s problems are deepening rapidly and as the German chancellor awaits the troika report, the Greeks are considering the options, writes RICHARD PINE Irish Times 25th. May 2011

IRELAND IS not Greece,” TD Tommy Broughan said recently. Unfortunately he is wrong, because, despite the different reasons for the two countries’ financial crises, Ireland and Greece are converging dramatically in the so-called “hardball” game with German chancellor Angela Merkel.

Greece’s problems are deepening rapidly, as the apparently inescapable choice must be made between an additional €60 billion bailout (making €170 billion in all) or a debt restructuring which would have colossal knock-on effects for the euro zone as a whole.

For the man in the street, two words sum up the dilemma: utter confusion. No one denies the causes of Greece’s economic collapse and social breakdown: poor administration, lack of planning expertise and an overstaffed public service. The confusion is caused by the fact that no one really understands how the terms of the bailout can have been imposed on a sovereign state, or how the troika of European Central Bank, International Monetary Fund and European Union investigators carry out their task.

Even more perplexing is the way that prime minister George Papandreou, after an impressive start in the negotiations, has perceptibly lost political clout as Dr Merkel unilaterally adopts the high ground.

Tension between the troika and Greek officials has been worsening, but up to now neither Papandreou nor finance minister Papaconstantinou have been able to stand up to them.

When Merkel announced that, when she receives the latest report from the troika, “only then can I decide what needs to be done”, Greeks collectively gasped in disbelief: “who does she think she is?” Now, according to the latest conspiracy theory, it seems the EU has one boss. This is rattling the Greek nerve.

Internationally, commentators are floating the idea that Greece might abandon the euro and return to the drachma, not merely as a way of escaping its indebtedness but as a means of reasserting sovereignty. If the country is bankrupt – and here is another painful parallel between Greece and Ireland – then let it be bankrupt on its own terms.

Reintroducing the drachma would effectively mean Greece turning its back on its creditors, which in moral terms could hardly lower its international profile any further, but it would immediately signal a halt to recession and an increase in exports, of which tourism is the most significant.

Merkel seems to favour a second bailout as the lesser of two evils. But it also seems that, after the troika reports next month, she will seek even harsher penalties than have already been imposed. Greeks believe that in this case Papandreou has little alternative but to pull the plug, as Papaconstantinou threatened to do at a “secret” meeting in Luxembourg on May 6th – a meeting which its convenor, Jean-Claude Juncker, initially denied had taken place.

If, as expected, the troika’s report is unfavourable, the next bailout tranche of €12 billion might not be paid without new conditions being attached, which would effectively mean Greece would have to raise the white flag. One in three Greek households polled nationwide on May 8th wanted the country to walk away from the bailout and 45 per cent wanted to renegotiate the terms.

Resistance to change, even when change is acknowledged as inevitable, is widespread, not least on the subject of the sale of assets, which the troika insists in Greece’s case should raise €50 billion by 2015.

As in Ireland, this is fast becoming a non-runner, even though it is a concrete condition of the bailout payments.

For the simple-minded, Dickens’s Mr Micawber had the answer: income €1, expenditure 99 cent, result: happiness. Income €1, expenditure €1.01, result: misery. In simple economic terms, you cannot run a country into debt any more than you can in your own household (from which we derive the Greek word economikos) – unless, of course, you are encouraged to do so by your friendly bank manager.

Which is where the Greek confusion comes in again: how could we possibly have got into this mess, or more particularly, if there are superior international forces, how were we allowed to go so far? And who is likely to lend more money to a country which cannot pay its existing debts?

Greece’s international profile may deserve a zero rating, but its people do not. In the village where I live, there is no air of guilt or self-pity but a general sense of bewilderment as to what the consequences of all this high finance will actually be.

Most people with whom I speak have no problem with the idea of modernisation, which is one of Papandreou’s driving passions, and the changing face of the village is a sign that “progress” is already happening from within.

But there is a residual anxiety about a way of life that is based on survival, fear and resentment. As any Irish person will tell you, 400 or more years of subjection breed resistance to authority – a problem which runs throughout the Balkan states.

There may be huge social and economic differences between Ireland and Greece, but the Greek in the street is rapidly learning just how much he has in common with his Irish counterpart.

Phase #2 of the Euro-Zone Debt Crisis

Phase #2 of the Euro-Zone Debt Crisis

by Gary Dorsch | may 26, 2010

“A trend in motion, will stay in motion, until some major outside force, knocks it off its course.” For almost fourteen uninterrupted months stock markets around the globe were climbing higher, recouping $21-trillion of wealth since hitting bottom in March 2009. The global economy was pulling out of its worst recession since the 1930’s, led by locomotives in China, India, and Brazil. On May 4th a survey taken by JP Morgan showed that global manufacturing expanded at its fastest pace in six years in April as output and new orders surged to new multi-year highs.

In the United States factory activity was firing on all cylinders, lifting the Purchasing Manager’s Index (PMI) to a six-year high at 60.4 in April, with employers becoming increasingly confident about hiring. Although manufacturing is not a huge component of the US-economy the factory industry is still where recessions tend to begin and end. For this reason the factory PMI is very closely watched, setting the tone for the upcoming month and other key economic indicators.

The US economy added 570,000 jobs during the first four months of 2010. In sharp contrast, just a year earlier, the US economy was losing more than 700,000 jobs during the worst months of the “Great Recession,” which began in December 2007. Still there’s been a worrisome undercurrent lurking beneath the surface – the U-6 jobless rate, including those who can only find part-time work or are too discouraged to look for a job, rose to depression levels of 17.1% in April highlighting the deepening impoverishment of the American middle class.

Still, traders on Wall Street saw the glass as more than half full rather than half-empty. The key numbers were still turning up spades. The combined net income for S&P-500 companies in the first quarter were 46% higher from a year earlier, helping to fuel the S&P-500 Index’s 75% rebound from its recession low in March 2009. Analysts on Wall Street upped their forecasts for S&P 500 profits to grow 29% this year and 19% in 2011, the biggest two-year advance since 1998.

Bullish traders bought increasingly expensive stocks on all dips, comforted by a steady stream of remarks from Fed officials promising to keep the fed fund rates locked near zero percent for an “extended” period of time. So powerful was the hallucinogenic effect from $1.75 trillion of liquidity injected into the markets by the Fed that speculators bid up the Dow Industrials to the 11,200 level, just shy of the 11,450 level – where horror story of the Lehman bankruptcy began.

Yet according to a Bloomberg opinion poll dated March 19th-22nd, there was always a big “disconnect” between the bullish perceptions on Wall Street and the fear and trepidation felt by workers on Main Street. There was great disbelief in the theory that the Fed could simply inflate the US economy to prosperity. Barely one in three Americans thought the economy was on the right track, and less than 10% predicted the economy would be strong within a year. Most American investors plowed their remaining savings in bond funds and missed the “green shoots” rally.

Still, the strategy pursued by the Fed and US Treasury were rather simple – inflate the value of the stock market through any means possible, including massive money printing, pegging interest rates at ultra-low levels, clandestine intervention in the stock index future markets, and jigging the accounting rules for valuing toxic bank assets. Eventually, the “wealth effect” would kick in and consumers would increase their annual spending by 3.5 cents for every dollar of added wealth. The Fed’s QE scheme opened the monetary floodgates driving high grade and junk bond yields sharply lower, and fueling a $5.5 trillion recovery of US-stock values.

But just as US consumer confidence was rebounding to a two-year high, buoyed by the Dow Industrials’ rally above the 11,000-level and US-home prices showing a year-over-year gain of 2%, the first increase since 2005, “a major outside force, began to knock the stock markets off their upward course.” Few traders would realize how the tiny nation of Greece with just 11-million citizens could bring the world economy to the brink of another Lehman-style meltdown.

Few traders on Wall Street took notice of the obscure and thinly traded Greek credit default swap (CDS) markets. There was a sense of complacency about talk of a Greek debt default, with traders reckoning that at the end of the day politicians in Germany and France would ultimately bankroll a massive bailout and prevent panic and fear from spreading to other highly-indebted Euro-zone countries, like Portugal or Spain, and plunging the Euro into a death spiral.

However, lying beneath the surface of the euphoria on Wall Street a ticking time bomb was winding up and getting ready to explode. The villain igniting the fuse was a most unlikely source – the S&P credit rating agency – which usually lingers far behind the credit default curve. Surprisingly, S&P roiled Euro-zone politicians and shocked the markets on April 26th by downgrading Greece’s €300 billion of debt three notches to junk status, at BB+, and thus, derailing the upward trajectories in industrial commodities and global equities. 

In the eye of the storm Greek CDS rates soared towards 1,200 bps, and yields on Greece’s two-year notes jumped to 25.8 percent. Suddenly stock markets in the fastest growing emerging markets in Brazil, China, and Russia were at the gates of bear market territory after suffering steep losses of 20% or more. Crude oil plunged $23 /barrel to as low as $64 /barrel, and there was a 20% shakeout in the copper market. The Australian and Canadian dollars tumbled 12% and 7% respectively amid a flight from natural resource shares and monetary tightening in China.

On May 7th, EU monetary affairs chief Olli Rehn spoke about the need to avoid a Greek default on its debts at all costs. “Little did authorities of the United States know in September 2008 what the bankruptcy of investment bank Lehman Brothers would lead to. The consequence was that the world’s financial system was paralyzed in a way that led to the biggest global recession since the 1930’s. Consequences from Greece’s insolvency would be similar, if not worse,” he warned.

Rhen’s apocalyptic warnings were taken very seriously. Euro-zone finance ministers and central bankers huddled behind closed doors during the May 8-9th weekend working frantically to craft a bank bailout plan before the opening of the Asian stock and currency markets on May 10th. What emerged was “shock and awe” – a 750-billion euro ($1-trillion) bailout package, including standby loans and guarantees that could be tapped by Euro-zone governments that were shut out of the credit markets. Putting the squeeze on naked short sellers the Spanish IBEX Index jumped 15% in a single day and the Euro briefly jumped to a high of $1.3100.

Since May 10th however the “shock and awe” effect has worn-off. The Spanish stock market index has completely surrendered its one-day gain of 15%, and the Athens stock index has retreated to within 5% of its March 2009 lows. The Euro has failed to gain any traction and is still sliding lower along a slippery slope towards parity with the US dollar. While the $1 trillion bailout succeeded in preventing an immediate default on Greece’s sovereign debt, the cost of borrowing for Greece’s biggest banks remains prohibitively high, which could choke its economy to death.

Thus, the focus of the second phase of the European debt crisis has shifted from the specter of a sovereign bond default to a frightful situation where European banks may become unwilling to lend money to the private sector, or could demand higher interest rates or impose tougher collateral rules. In other words, the markets fear a “double-dip” liquidity crunch, which could deprive European companies with junk bond ratings of badly needed funds as banks become more risk averse.

Since May 10th credit default swaps for the Euro-zone’s top 50 junk rated bonds has surged to as high as €625,000 to insure €10 million of debt. That’s up sharply from €460,000 since the $1 trillion bank rescue plan was announced. In fact, the European corporate bond market has been effectively shut down for banks with bond issuance slumping to $2.6 billion in May, down from $82 billion in January.

Amid fears of a liquidity crunch in Europe there are expectations in the gold market that the ECB would respond by ramping up its money printing operations to full throttle, and in the process exerting further downward pressure on the Euro. As of May 21st the ECB had already bought 26.5 billion Euros worth of sovereign bonds as part of its agreement to monetize the debts of the most fiscally irresponsible Euro zone governments. The ECB might end up monetizing as much as 750 billion Euros of sovereign debt, including riskier bank bonds, to avoid a full blown crunch.

After climbing to a record 1,000-euros /oz in mid-May, Gold endured a brief pullback tumbling in tandem with sharp slides in crude oil, copper, nickel, rubber, and other industrial commodities. But gold has proven itself a very resilient metal and highly sought after as the purest form of “hard” currency, shining brightly as a hedge against paper currency devaluations and the monetization of government debt.

The European Central Bank (ECB) has crossed the Rubicon agreeing to monetize hundreds of billions of Euros held in Greek, Portuguese, and Spanish bonds. In the process the supply of Euros in world money markets is likely to increase. The ECB’s efforts at sterilizing the bond purchases are voluntary and have been feeble at best. Furthermore, at the end of the day, there is little chance that Greece’s 2.5 million working citizens can repay 300 billion Euros of debt, while at the same time absorbing 25% wage cuts in the public sector and paying 23% VAT taxes.

At some point Greece’s government would seek to untangle the noose strangling its economy and demand a restructuring the country’s debts, and in a polite way tell its lenders to take a big haircut. Argentina is holding a $20 billion debt swap this month at 45 cents on the dollar, nine years after defaulting on $95 billion of loans. The Euro would remain a very unstable and weak currency. Reports that Beijing is becoming increasingly nervous about its Euro zone bond holdings drove the Euro to as low as $1.2180 and fueled a flight for safety into gold.


Gary Dorsch
SirChartsAlot, Inc.

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