EU Summit 21 July 2011: The Greek Bailout (Take Two)

For the eurozone, July 21st 2011 was a day that will live in infamy…

Well not really. European leaders agreed a revised second bailout package for Greece on top of the €110bn from the troika (EU-ECB-IMF) the Greeks got in May 2010. But wait, theres more! Heres a summary:

  • Greece gets another €110bn (for a running total of €220+) from the troika
  • The role of the European Financial (Rescue) Stability Fund or EFSF (a huge €440bn pot of euros guaranteed by the remaining AAA credit rated eurozone nations) will be expanded into a quasi-European Monetary Fund with PIIGS debt/bond buying power, stronger regulatory control of the banking sector and conditionality on aid, giving Germany and France a bigger say in EZ economies
  • Allow ‘Bond Exchange/Swap’ – an orderly exchange of current Greek bonds (due to be paid back by an insolvent Greek government) for future bonds, giving Athens more time to pay its debts – from 7.5 years now to 15-30 years (up to 40 in some cases). If Greece goes bust, many EU commercial banks will follow so theres a BIG incentive for them to help out
  • EU-IMF package interest rate cuts for Portugal, Ireland and Greece (to around 3.5% from 5-5.8%)
  • A mini ‘Marshall Plan’ to kick start some growth in the Greek economy
  • Bondholders of Greek debt must accept a 21% ‘haircut’ in the value of their bonds (Greek bondholders =  mainly Northern European banks i.e. German, Dutch, Belgian and French banks. They are being made share the burden)

Of course, now we have the economics – we’re soon to be knee deep in politics (this is the EU after all). The EFSF cannot use these new powers until Late September or more likely early October as this change requires parliamentary approval across the EU-27

The US debt debate (debacle?) showed that even stateside, politicians and commentators have difficulty separating too seemingly similiar issues. Lets clear up the confusion. In the PIIGS and beyond, we have two similar yet unique problems.

  1. First we have the  problem in the government’s current account. This is the day to day revenue (taxes) and spending (public expenditure on health, transport, education, interest on the national debt etc). For many countries, especially in Europe, this is in deeply negative territory (as you’ve expect in a recession as economic activity lulls, people stop spending, jobs are lost, social welfare payments rise with the unemployment level).
  2. Second we have the national debt problem (aka the sovereign debt problem – as this sounds decidedly macho-er). This is the sum total of what the country owes or as CJ in the West Wing put it ‘the national credit card.’ The greater the debt you owe, the higher the interest payments and this then affects the current account…meaning more money down the drain paying interest on the debt (called ‘servicing’ the debt) and less money for schools, hospitals etc

Under the Maastricht Criteria (the entry conditions countries must meet to be accepted into the euro), the first must be not more than 3% (unless in exceptional circumstances) and the second must be not more than a GDP:Debt ratio of 60%. Greece never really met these conditions (at entry and as time went on) and things have become far worse lately with Greek debt likely to rise higher past 150% of GDP by 2012, with sustainable levels around 60-80%. Solution? If day by day deficits are forcing the country to borrow more, raising the national debt, then what can a country do? Usually, countries just grow out of deficits…as their economies grow =more jobs are produced = more people in employment = more taxpayers = higher government revenue = less need to borrow = balance the books! (Health warning: In theory).

Ah, but there’s another problem – Greek banks refuse/are unable to lend money. Without money being lent out, your economy cant recover as a lot of business is done on credit. Under the 21 July agreement, the eurozone 17 governments (EZ-17) will provide €35bn to Greek banks to lend out and kick start the economic engine.

As you can see…even with the July 21 plan, the real problem is the size of the €350-370bn Greek national debt. It feeds directly into the Greek current account. Because the problem is in the short term (panicky atmosphere around Europe about the survival of the euro, the eurozone cannot wait for Greece to grow its way out of recession. It needs to restablish Greek credibility by fixing the current account (through the EU-IMF austerity plans involving the forced selling of state assets, higher taxes and huge spending cuts). This however does not fix the national debt problem. It only stops more being added to it. But austerity sucks money out of the economy and reduces the growth prospects. My economics teacher in school used to say that the economy is like a giant bath tub (apparently its called the ‘Bathtub theorem.’) From the tap comes more water (public investment) in the form of exports (income from these), government spending and investment. Occasionally the plug is lifted and out flows savings, imports (money spent on these) and taxes. The water level is national income (all the incomes all businesses and individuals), all sloshing around. Combining austerity with a mini-‘Marshall’ stimulus is a bit like turning on the tap and pulling the plug at the same time. The Greek austerity plan is truly awesome, a €28bn correction over the next 4 years with a 50:50 split on spending cuts and tax increases (roughly €14bn each). That’s before you consider the four year €50bn privatisation plan to offload the family silver, with ports, airports, state lands, mining rights, highways, banks and telecom giants all facing the chop. Austerity plans when economies are flatlining were used by the US Hoover Administration in the 1920s/30s at the time of the Great Depression and aren’t seen as the most ideal model to imitate (to say the least) considering how long the depression lasted.

In any event, Greece’s sovereign debt problems at €350bn are dwarfed by Italy’s at €1.6tn. Whatever cash the troika can find down the back of their sofas for Greece, Italy is a far different story. A recent Italian €48bn austerity plan has apparently not stopped investors betting on an Italian ‘situation’ be it default, debt restructuring or divine intervention. Investors expect Italy to be ground zero for one simple fact. No one can afford to bailout Rome. And with Spain facing a general election on 20 November, the footdragging has recommenced.

In the Canadian Financial Post, one quote summed up the urgency at EU level well…

“With many policymakers on holiday, there seemed little prospect of early European policy action, although euro zone governments were in telephone contact about the situation.

Comforting. A Greek island paradise I wonder? Hmmm….

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