E.U. Greece Bailout Fails to Defuse the Ticking Global Debt Bomb
Jon D. Markman
May 11, 2010
The ticking global debt bomb is in the in the spotlight again. Or, at least, it should be.
Greece’s woes draw attention to the looming financing problems of other countries with a lot of debt. The strain of funding these requirements – the global debt bomb – is the greatest threat to global growth prospects. This is why central banks have flooded the financial system with money. It’s the biggest and most critical financial battle of our time.
The Bank for International Settlements – essentially the central bank of the central bankers – said as much in a recent research paper, noting that governments around the world are overspending in an effort to make up for the lack of activity from cash-strapped consumers and companies. To maintain those high spending levels at a time when tax-receipts are down, however, governments have no choice but to borrow – a strategy that they cannot follow forever, BIS researchers said.
“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable,” the researchers said. “Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.”
A Weak Greek Week
Outside of Manhattan – where a stock-market panic sent U.S. shares into a virtual nose-dive late Thursday – riots in Greece were the headline story of last week, since images of the heirs of Socrates throwing Molotov cocktails at police made for great theater. The $962 billion “stabilization mechanism” (rescue plan) unveiled after an emergency meeting in Brussels, Belgium, on Sunday will return the focus to the financial part of the crisis. The package is designed to prevent Greece’s debt crisis from turning into a contagion that infects other EU-member countries.
Will this help? Prior to Sunday’s deal, I contacted the ace credit analyst Satyajit Das at his office in Australia for his views. According to Das, Greece is a hazard that exceeds its small size. In response to my email, he sent a very long, helpful answer.
Indeed, the detail is so interesting that I’ve reproduced sections of his response in full:
“Greece’s immediate problem is solvency, but also liquidity – it must find cash to roll over existing debt. Greece needs around 50 billion euros ($64.2 billion USD) in 2010, of which around E25 billion ($32.1 billion) was needed by June. In early April 2010, with characteristic insouciance, Greek officials assured creditors that they were fine till end the end of the month! The market called their bluff.
“Unfortunately, the Greek financing problems run far deeper. From now through 2014, Greece needs to refinance borrowings of around 10% of its GDP each year, with major maturities occurring in 2011 and 2012. In addition, Greece is currently running a budget deficit of over 12% that must be financed.
“Greece’s total borrowing, currently around E270 billion ($346.5 billion), is forecast to increase to around E340 billion ($436.4 billion, or 150% of gross domestic product) by 2014. So in all probability, Greece will need E30 billion to E50 billion ($38.5 billion to $64.2 billion) each year for the next five years to meet maturing obligations.”
According to Das – and this is important – Greece’s problems were inevitable. Like many of the economically weaker European Union members, Greece manipulated (“fudged”) its numbers in order to meet the requirements for entry into the euro community.
The sharply lower euro interest rates set off a credit-driven real-estate boom and fueled chronic over-borrowing. Furthermore, Greece lost both its cost competitiveness and its ability to manage its own economy. It lost the ability to use its currency, via devaluations, to improve its competitiveness and stimulate its exports.
And that’s not all. Greece lost the ability to set interest rates (now set by the European Central Bank, or ECB). It also cannot print its own currency to fund sovereign borrowing. That’s a problem since the country’s low levels of domestic savings make it heavily reliant on international capital flows.
That brings us to March 2010, where credit analyst Das picks the story up again.
“Fast forward to March, 2010. After bitter negotiations, the European Union and International Monetary Fund, or IMF, announced a bailout package. The flowery rhetoric of ‘familial’ duty and EU ‘unity’ were taken at face value by gullible investors who assumed that the problem was fixed. When the solution proved not to have solved the market’s concerns, a new package was announced in April 2010. In reality, the April package is highly conditional and [did] not address core issues.”
The EU’s “New Deal”
That brings us to the deal that was hashed out in Brussels over the weekend. Needless to say, both Greek and EU officials proclaim it a winner.
Greek Prime Minister George Papandreou told CNN that the volatility in the financial markets made it impossible for his country to buy the time required to implement the kind of deep reforms that Greece’s ailing economy really needed.
“But [then] Europe stepped in order to regulate the markets in a way which would allow us to make these changes,” Papandreou said.
With some tough-sounding talk, Olli Rehn, the European commissioner for economic and monetary policy, also gave an upbeat assessment of the financing package, noting that “the fiscal efforts of European Union member states, the financial assistance by the (European Commission) and member states, and the actions taken today by the (European Central Bank) proves that we shall defend the euro whatever it takes.”
Given the hugely positive reaction of the global financial markets in early trading yesterday (Monday), investors and analysts are once again buying into the “party line,” and apparently see this as a fine solution. Marco Annunziata, chief economist at Italian bank UniCredit Group, told Britain’s Telegraph newspaper that “this is Shock and Awe, Part II and in 3-D. This is truly overwhelming force, and should be more than sufficient to stabilize markets in the near term, prevent panic and contain the risk of contagion.”
Das points out that “Greece’s problems are probably incapable of solution and its financial condition is terminal. Temporary emergency funding may help meet immediate liquidity needs but do not solve fundamental problems of excessive debt and a weak economy.”
”Greece has limited opportunity to grow or inflate itself out of the problem. Without the ability to devalue the currency, Greece cannot address its fundamental lack of competitiveness quickly. The narrow economic base, primarily agriculture, tourism and construction, further limits options,” Das said. “The magnitude of the adjustment is staggering. Greece must cut its budget deficit form it current levels of 12-13% to around 3% over the next few years. This is around twice the reduction required by Argentina in the late 1990s, which that country failed to achieve.”
Any deal merely changes the form and ownership of the risk. It doesn’t eradicate it.
Warning: Don’t Ignore the Global Debt Bomb
For the moment, unfortunately, everyone seems to have forgotten the “global debt bomb.”
Everyone, that is, except my colleague Das, the global-credit expert – and, of course, those of us reading this anlysis.
“The current debate misses the fact that the bailouts are mainly about rescuing foreign investors,” Das said. “These investors were imprudent in their willingness to lend excessively to Greece, assuming implicit EU support, and are now seeking others to bail out them out of their folly.”
Said Das: ”The problems of contagion in highly inter-connected economic and financial systems have not abated. The latest data shows that Greece owed US$276 billion to international banks, of which around US$254 billion was owed to European banks with French, Swiss and German banks having significant exposures. What happens in Greece is unlikely to stay in Greece creating new problems for the fragile global banking.”
The bottom line, according to Das, is that “Greece highlights a few new and old truths about the global financial crisis. The level of global debt has not been addressed. Sovereign debt was substituted for private-sector debt. As trillions of dollars of private and government debt matures and must be refinanced, the next stage of the process of de-leveraging will play out. Vulnerable borrowers, such as Greece and earlier Dubai, highlight this risk.”