A Euro Crisis Here, A Euro Crisis There….

November 16, 2011

Europe has come a very long way from its early days where geopolitics and security concerns trumped pure commonsense economics (great oxymoron there!). PIIGSty is going to go out on a limb here and suggest that, if you strip away the hysteria and overreaction, Europe is more secure than it first appears. The problem in Europe isn’t necessarily the economics. Using the logic from a number of commentators, we have compared a number of European countries most featured in recent debate. The categories are:

  • High Risk: PIIGS – Portugal, Italy, Ireland, Greece and Spain
  • Moderate/Mid Risk: France and Belgium
  • Low Risk: Germany, Netherlands and the UK

Budget Deficits

The correlation between the actual figures and the perceived ‘risk’ according to most commentators is puzzling at first glance. The following table outlines the change since the formation of the euro in 1999 (Greece having joined in 2002 and the UK a non-member for comparative sake).  The slide in budget balances give is uniform across the board. The PIIGS look like the worst offenders…but Italy (@ 2.9% change) looks quite stable. The erosion in the public finances in 2010 gives an insight into why Ireland, Greece and Portugal requested an EU-IMF bailout deal. Spain however, with a worse situation than all three, did not. Italy witnessed a moderate change from 1999  levels of less than 3%, similar to ‘moderate risk’ nations of France and Belgium. The Italian problem must lie elsewhere.

*The Irish figure amounted to a deficit of €50.3bn including an exceptional refinancing cost to prop up Anglo Irish Bank  of around €32bn-€34bn . Without this, the level would be about 12%

Debt: GDP

So, clearly the level of sovereign debt in the PIIGS is quite substantial. Ireland, Portugal and Greece (all EU-IMF bailout recipients) have increased their sovereign debt levels by almost identical levels since the formal creation of the euro in 1999.  Italy and Spain have very different (and more modest) results.

Putting all this together pictorially, we get…


Conclusion

The picture isn’t as straight forward as some commentators suggest. If its all about sovereign debt, then why is Italy suddenly a ‘panic’ problem when the level of debt has changed very little since 1999. Spain has even witnessed an improvement in its position since its entry into the euro.  Looking at budget deficits, its clear that some countries (UK, France, Belgium and the Netherlands) are arguably not in a comparatively better positions than Italy. The ‘High Risk’ category is sufficiently large and feasibly encompasses a wider selection of European countries than is clear at first glance. Truly, the problem of debt and budget deficits is more of a European problem than some countries are willing to admit.

You never know. Is it possible some countries are more willing to pass the burden onto the PIIGS to avoid scrutiny and their own economies by investors? Is this all about governance? Are countries with more stable governments (such as in the UK) more likely to weather the storm and thus their technically ‘High Risk’ position isn’t viewed as serious by the markets?

Food for thought at least…


The Tipping Point for Italian Bond Yields

November 9, 2011

Hysteria has returned and analysts are running around declaring Euro-doom. Not a rare thing these days but calmer heads should prevail and appropriate analysis shared. Now, for Europe and the euro, its all about Italy. No surprises there as Italy has been on the radar of European leaders as a ‘worst case scenario’ yardstick for months. Effectively, we’re entering the ‘we’re all screwed’ area of European economic diplomacy. Its becoming too late to make the decisions that should have been made when the sovereign bailouts began with Greece in May 2010 (nearly 18 long months ago).

Berlusconi’s Bond Yield Boom

So, Italian bond yields are rising sharply. We all know why this is. First, and foremost, the ECB were actively engaged in frantically buying Italian bonds to keep the yield rate artificially low (to buy the politicians time to come up with a lasting solution…which hasn’t happened). Secondly, and most recently, politics has intervened with Berlusconi’s eventual resignation becoming the key issue…and the likely ‘headless chickens’ election clamour that will succeed his stepping down as PM. Italy isn’t exactly an exemplar model of stable European governance (it has had 62 governments since the end of WW2 – effectively 1 a year). Most Italian PMs rule with a shoestring majority and shifting coalitions with their tenures usually ended before any real ‘governance’ takes place. Berlusconi won an outright majority in 2008 (but has been beset by underage sex scandals and corruption allegations leveled at the billionaires media empire). All this makes for fascinating innuendo and tabloid headlines but nothing for steering Europe’s 4th largest economy (Worlds 8th largest) during a very challenging economic environment.

In a previous in-depth PIIGSty musing , we assessed the ‘tipping point’ for requesting EU-IMF bailouts at around 7-10%. This is the danger zone.

How does Italy fare? (November 9, 2011)

You can see why (purely simplistically) why European leaders are starting to get extremely nervous. Italy, with €1.9tn of sovereign debt is over 7.5 times the ‘new’ level of Greek debt of €250bn after the October 27 Agreement. Italy is also ‘too big to rescue’ under the current €440bn EFSF fund. Even with IMF help, Italy appears a bridge too far. Europe has dithered and participating in reactive patchwork decision making and ‘sticking plaster’ solutions for the past 18 months.

Time might have just run out.


Greek PM Papandreou Seeks to Rekindle an Old Flame (…the eurozone Debt Crisis and the October 27th plan)

November 2, 2011

The aftermath of the recent October 27 EU summit, a recent article by Dunstan Prial for Fox Business News summed up the current state of affairs in the eurozone (EZ) debt crisis brilliantly “Europe puts out the fire but theres still a lot of smoke.” And less than a week later, Greek PM George Papandreou, to massive surprise from European leaders, decided to provide a fresh spark – and called for a referendum on the overall Greek bail-out plan to be held as early as December 4th (this call has since been endorsed unanimously by the Greek cabinet).

The Three Pronged Greek Bailout Plan

This ‘plan’ is effectively 3 plans with 3 bailouts in one form or another since May 2010. It ain’t pretty. For the Greek government, this means receiving a running total of €340bn+ of EU-IMF aid in exchange for agreeing a series of tough reforms: slashing public pay, a €50bn privatisation programme (by 2015), deep labour market reforms , new taxes and committing to repayment of the remaining Greek national debt (Just sliced down in the most recent plan to around €240bn from €340bn). Granted, the plan is extremely draconian and is vehemently opposed by working Greeks. A valid criticism does exist with the European obsession with following Merkel – the ‘High Mistress of Austerity’ as the UK Daily Telegraph referred to her – by shrinking the size of economies when they need to grow. Regardless, the plan as proposed and the effective economic leadership of the Greek economy by Franco-German dictat is the only thing keeping Greece credible in the eyes of the markets.

The Almighty Greek Gamble

With a shoestring majority in parliament, Papandreou’s government is already extremely weak and desperate to regain some popular support in the midst of deep social unrest. This is a major gamble. Sometimes, such a gamble can pay off handsomely. On the 26th of October, Merkel herself gambled by holding a full Bundestag vote on a further expansion of the EFSF prior to an EU summit, when it wasn’t necessary (a special parliamentary committee is gifted by the powerful German Constitutional Court to do this). In the end, she won a mandate in EU wide negotiations, with 503 of 596 MP votes.  For Papandreou, his gamble has put a gun to European leaders heads – and they aren’t in the best mood for more compromise. They’re already rapidly exhausting their own political capital with no short term gain. One could guess that they are gambling that the much more favourable terms of the October plan (compared to the early July version), suggest that forcing Europe to try again will produce another even more favourable (pre-referendum) plan. Thats the presumptive theory, as PIIGSty sees it.

Problems

While all this might make everyone feel slightly more comfortable, there are some very obvious problems…

  • Greek Debt: GDP of 120% is more sustainable than the (currently projected) level of 165-175% for 2012 – but who is to say that even this is sustainable. A level of 120% is the same as the current Italian level of indebtedness which is causing such consternation. Studies, notably those by Rogoff and Reinhart have suggested that 90% is the most feasible level which won’t cripple growth or risk insolvency (and so convince the markets)
  • EFSF: The proposed increase from €440bn to €1tn is mainly through promises of Asian assistance (or partnership) and providing ‘insurance’ on bond purchases on 20-30% of the value. That still leaves 70-80% ‘uninsured’. Both aspects are far more vague and of debatable relevance than they might first appear. The risk remains AT ANY PRICE!
  • The Greek Bottomless Pit (and that Referendum): For Europe, giving Greece nearly half a trillion euro (in either direct bailout funds or write downs) and receiving weak assurances, and reluctance to reform while market turmoil continues unabated – is pushing Merkel and Sarkozy (and their governments) into full and open questioning about whether Greece should remain in the euro and, by natural extension, the EU. Saving Northern European banks, for now, might seem worth the effort. If the Greek bailout ‘referendum’ fails, then – whether the Greeks like it or not – their state will be declared insolvent by the markets and face a messy default. Those Northern European banks which can’t absorb the impact of a Greek default will also find themselves insolvent.
  • The Northern European Economies: With a combined €750-€800bn of debts and sluggish interbank funding, the economies of Northern Europe are very aware of the ticking ‘Lehman’ time bombs on their doorstep – considering their exposure to the PIIGS.  Should the sovereign debt crisis require deeper and deeper haircuts on PIIGS debt, the solvency of these banks is put in doubt.  The prospect of large scale bank write downs is the reason European bank shares rise or plummet with the success or failure of sovereign debt plans.

That’s a short summary of the remaining problems…

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Writing Down Greek Debt: European Leaders Start to the Get Serious

October 24, 2011

After the EU-wide calamity and impending doom of the past few days and weeks, you would rightly query what exactly is now going on. Its pretty straightforward – European leaders are starting to get serious. The key element of the October 23rd summit was a sea change in the dialogue. The Franco-German duo of Merkel and Sarkozy have stopped insisting on minor sticking-plaster solutions and have belatedly began to talk about more serious surgery including a keystone proposal to write down (haircut) a substantial portion (40-60%) of Greece’s €350 national debt pile. This would make it hugely more manageable. After listening to the weekend views of the G20 (who are, no doubt, in convulsions over the prospect of a European engineered second ‘double dip’ world recession), there is no doubt the conversation has changed.

EU leaders are not formulating a full scale multifaceted rescue plan to tackle the underlying problems. Previously, the focus was skewed to address urgent liquidity problems, with tackling solvency a long term (#2) aim. Now, the short term focus is starting to change, and with good (economic) reason.

The ‘Liquidity’ Era 

For too long, as economist Ken Rogoff outlines in Der Spiegel the discussion in eurozone circles was squarely focused on addressing liquidity problems (getting the day to day financing in order) for those countries most at risk of going bankrupt – Portugal, Ireland and Greece. Remember it was doubt over their ability to pay for the functioning of their own economies which caused their borrowing costs on the bond markets to skyrocket – and caused the creation of the EFSF and the EU-IMF bailouts. But all this has proved ineffective to stop the rot. Greek needed a second bailout less than 7 months after its first and the on-off panic encouraged by the Greek government dragging its feet on meeting its obligations. Releasing the bailout funds in tranches after regular reviews by the troika (European Commission – ECB – IMF) has injected more instability than certainty into the process.  With the Greek government promising to get its debt in order by dramatically altering labour laws enshrined in the Greek populace for generations, drastically reducing the size and cost of the public service and budgetary measures such as increased taxes and deep spending cuts – the calamitous environment is ruining investor confidence and prospects for a return to economic growth in Europe and beyond.

The ‘Solvency’ Era

So, the real problem is Greece or more accurately, Greek solvency and the interdependent solvency of the big European banks. Unlike what was believed previously (in the ‘liquidity’ phase), Greece has very weak structural economic strengths to fall back on). A disorderly Greek default would put the solvency of those indebted European banks into question (and with them, the economies in which they operate across Northern Europe). Therefore, there is no stable bottom to this crisis.

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Merkel and Sarkozy Seek to Batten Down the Hatches before the Big Storm

October 10, 2011

German Chancellor Merkel and French President Sarkozy agreed Sunday (9 October) to recapitalise and therefore shore up European banks to the tune of €200bn to storm-proof them in case of another major shock to the financial system (if need be…). Is this a good or a bad move?

Well, its both.

Good

  • European leaders are starting to think seriously about tackling the solvency and liquidity crises in major European banks (‘encouraged’ by last weeks collapse of the Franco-Belgian lender Dexia)
  • A united Franco-German effort is a show of strength and calm amid the crisis atmosphere
  • Tackling the ‘bank’ problem should, in theory, stop the bleeding quicker should a major negative financial event occur on the scale of the collapse of Lehman Brothers in September 2008.
  • Overall, shoring up the banks should stabilise investor confidence (to what extent is unknown) and therefore quell some volatility in the markets

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The PIIGS 10 Year Bond Problem

October 4, 2011

We all know why the PIGs have needed to source temporary financing/bailout funds from the EU-IMF  – it was just too expensive to continue borrowing vital operational funds through the bond markets (the usual route). Think of it this way. When investors (say, big German/French/Belgian/British banks) buy €1bn worth of Greek bonds, they’ll get €1bn back in 10 years + interest @ X%. This X% is the ‘yield’ (premium) to the investor but the ‘excess cost’ to Greece of issuing the debt/bond (i.e Greek borrowing)

Why would the ‘yield/cost’ go up?

  • Investors HATE risk. Risk costs money and risky investments aren’t likely to attract many takers.
  • Greek bonds are VERY risky because with all this talk about haircuts (slicing a chunk off the €1bn principle) to European bank debt in the PIIGS, investors may think that government debt could be next for the chop (in some way or another)
  • Buyers of Greek bonds will need encouragement for taking on more risk i.e a higher premium (a higher X%)
  • This means that investors buying Greek debt will demand more – and Greece will have to pay more. Greece can’t afford to pay more interest because it comes out of the funds that pay for the to day to day running of the Greek economy. Pressure on the flow of that cash could cripple the economy (and, you never know, cause a revolution).
  • So, Greece can’t borrow that way – it needs a bailout from the EU-IMF (or, more specifically, the ‘troika’ – the European Commission (EU), European Central Bank (ECB) and International Monetary Fund (IMF).

Interestingly, for each recipient of EU-IMF aid, the ‘tipping point’ (the cost or bond ‘yield’ at which countries was forced to ask for help) was different.

PIIGSty compares the situation then with the situation now, in October 2011 (approximated and rounded figures via Trading Economics).

On average, prices of 10 year bonds (cost of borrowing the usual way remember) have actually increased (its more expensive) across the three PIGs since the various bailouts were initiated (-4.5%). Greece has deteriorated significantly (obviously, considering the need for a 2nd €110bn bailout in July). Ireland and Portugal have coincidentally declined by approximately equal levels (-1.5%).

The tipping point for the PIGs have proven to be between 7%-10% (Greece 2 being the exceptional case) – this compares with current levels of 5.16% for Spain and 5.41% for Italy (and 1.77% for Germany).


Europe 2011: “An Intergovernmental Event of 26 Men and 1 Woman”

October 4, 2011

Here at PIIGSty.com – the issue of the inadequacy of the EFSF has been long discussed, an issue which has recently reared its ugly head again at meetings of the IMF and G20. We decided to sit back and wait for the hysteria to die down in recent weeks and for clarity to replace hyperbole. Since September 20th, we have learned some key things about the eurozone (EZ) crisis. Heres a run down of some activity in the key players.

Germany

Chancellor Angela Merkel has been triumphantly congratulated on her overwhelming Bundestag vote to expand the borrowing capabilities of the EFSF (as agreed in the July 21 meeting) and rightly so.  The vote also succeeded in stablising her CDU-FDP coalition with a combined 315 votes FOR and only 13 AGAINST) despite huge misgivings, meaning the crossover opposition support from the Social Democrats and Greens wasn’t as critical as some commentators had expected. Of course, the market pleasing 52385 vote victory is bittersweet. First, the good news. The good ship Europe was steadied temporarily and the media outlets ignored the Greek crisis for at least a day. The bad news. That same ship is essentially still hurtling toward the same reef, likely to founder eventually on those sharp (and self chiseled) Athenian rocks. The cannons can sink some foes along the way but the course is set if the wheel isn’t turned.

Why not turn the wheel? Europe is still playing catch up and continues to woefully and frantically follow events rather than lead them. The ‘Merkel wins’ narrative was always going to change. A €440bn EFSF is inadequate and the return to market turmoil in October confirms that. The fact that even a simple enlargement of the fund (which was more procedural than a sign of proactive EZ economic governance) has shown that any future necessary financing of bailouts or bank recapitalisations are just not on. The EZ’s effectiveness to deal with this crisis has now been formally politically neutered.

Germany will ultimately (after all EZ parliaments pass the EFSF reforms) be responsible for nearly 50% of the EFSF fund, around €210bn. The likelihood the ‘Merkel-Schaeuble (her Finance minister)’ doctrine of ‘no more bailout money’ will change beyond that is just implausible and politically suicidal.

Greece

Greece remains the problem child of Europe. Fostered under a European monetary system it never ascribed to wholeheartedly (since the Greeks were never too fond of following the rules of EMU) the Greek-fueled EZ debt crisis remains poised to cause a financial earthquake, especially if its spreads. To say this is only because of the petulance of some myopic Greek politicians isn’t fair but consensual decision making in Athens is proving elusive. Opposition parties are steering clear of the austerity and privatization plans, even objecting openly to the proposed cull of 30,000 public sector workers, despite the costly historical burden this sector represents – currently 45% of the entire Greek economy.

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