piigsty

Every article and news report on the European crisis seemed to mention the ‘EFSF’ – the European Financial Stability Fund. What is it and why is it important?

First things first, what is it?

Officially,  Its a triple A-rated eurozone private company run by the European Commission, European Central Bank, IMF and the Eurogroup (eurozone finance ministers). It is backed by guarantees from all 17 eurozone countries (but really, its the guarantees of the 6 AAA ones that matter).  It sells debt/bonds to raise money for bailout funds for countries in need and help them pay their short term debts  (keeping the default wolf from the door). It can also be used by a country to fix their banking sector (as in Ireland). But it cant just intervene. Countries must apply for funds and be accepted (so you better be in trouble because ‘applying’ is enough to make investors run for the hills). So it’s a means to an end – only to be used after euro-using countries cant borrow in the normal way from the markets.

How much is it?

Before reform proposals made in July are agreed, it has a ceiling of €250bn. Of this, €100-€135bn has been pledged to Greece (€25bn for 1^st bailout + €72bn-€110bn for 2^nd bailout), Ireland (€17.7bn) and Portugal (€26bn).  The July 21 reforms will see its lending ceiling grow to €440bn. Even if the reforms are passed by October across the EU, the pot is already reduced to between €260-€300bn after PIG deductions. If you want to get technical, because EFSF bonds are guaranteed up to 165% of their size, the EFSF crutch  (on remaining funds) is technically between €429-€495bn. In cold hard cash, the overall bailout fund, adding the EU’s €60bn and IMF’s €250bn is now between €570-€610bn.

Read the rest of this entry »

One often forgotten element to the massive debt pile Ireland must pay is the overall interest payments we must fork out each year. Ireland has two dual problems. The first is a sovereign debt crisis (which requires cash transfers from the EU-IMF in return for austerity programmes promising to restrain spending). The second is a banking crisis (which requires government guaranteeing major banks and paying bank debt in full to get the credit market flowing again without heavy penalties).

Here are the figures:

Potentially, the worse case scenario here would mean approximately €12bn in annual interest payments by 2012. For perspective, this would represent 85% of the entire 2010 income tax revenue.

Looking at the current state of the Atlantic economy, its pretty clear things are not going well.

On Thursday, 4 August 2011 – European markets fell sharply, the FTSE falling nearly -3.5% and the Dow Jones stock exchange falling 512 points (-4.3%). These are late 2008-early 2009 levels (the height of panicky season). Lets have a look at the key factors:

Americans Leading by Example

The US federal debt ceiling-fiscal austerity hybrid package which President Obama signed at the last minute on 2 August saw a simple procedural task do a depressing level of damage. The hugely fractious debate highlighted deep fissures at the political level with two distinct (and polar opposite) economic viewpoints dramatically colliding (one favours drastic cuts to federal spending, the other favours a streamlined but strong federal role). The perception that Republicans and Democrats are ideologically at war makes a compromise US economic strategy (on the only issue that really matters – jobs) now increasingly unlikely (if not utterly impossible) in the politically charged atmosphere running up to the Presidential election in November 2012. This, on top of dwindling consumer spending means the new austerity plan to slash public spending while the economy hovers above recession might be a heavy handed action at the wrong time. The likely result may be the feared ‘double-dip recession’ as investors run for the hills and seek short term gains in emerging economies, returning after the election (fingers crossed).

The other PIIGS – Italy and Spain

In the rank of worlds largest economies  – Spain is 8^th, Italy is 12^th. The markets/investors know all too well that whatever sticking plasters EU leaders conjure up, the EU-27 (including the eurozone-17) need to convince the market they’re serious about the problems and ready to solve them (a trait currently lacking). Something with economic teeth is urgently needed, backed up with far more cash and political solidarity than leaders have yet mustered. The figures do not tell a simple story. Spain has 20% unemployment with over 40% youth unemployment but has a very reasonable debt to GDP ratio (total output) of 75%. Italy has 8% unemployment with 28% youth unemployment with a severe debt to GDP ratio of 119% (2^nd only to Greece).

Read the rest of this entry »

For the eurozone, July 21^st 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.

Read the rest of this entry »

“Greece, like other countries, has to experience that if one doesn’t stick to fundamental rules of stability one has to pay a high price, which Greece can’t be spared from.”

– German Finance Minister Wolfgang Schaeuble

The recent crisis has revealed in very agonising fashion the endemic failings of EMU from a policy ‘one size fits all’ perspective. The usage of EMU by peripheral EU members to ‘leapfrog’ on the back of credible, creditworthy financially strong nations has led directly to the restructuring-default impasse of 2011. The consistent view of the financial markets is not default per se, but the risk of contagion from and between the so-called PIIGS and its effect on the larger more stable nations and, inevitability, on the European lender of last resort and anchor of the euro, Germany.  Aside from the rhetoric, fiscally speaking, just as a budget crisis in New Jersey or California cannot pull apart the US dollar, one in the PIIGS cannot, by itself, bring down the euro.

The real problem is that if the situation among the PIIGS is not uniformly the consequence of a sustained period of spending binges like some assert, than how can EU-European Commission-IMF (troika) force common austerity plans upon structurally and fundamentally different economies? For example, previous economic mismanagement and governmental profligacy is far more prevalent in the Greek case than the Irish case, which is predominately a fiscal crisis caused by a severe banking crisis. Does that mean preferential treatment is likely for Ireland? If not, why not?

The problem now is how, without the correction mechanism of devaluation to reinstate a competitive edge for exports do Portugal, Ireland and Greece return to economic health especially in the midst of painful deflationary austerity plans and, in the Greek case, future massive privatisation schemes and public sector wage slashing. As Krugman asserts, we are in a quite bizarre situation, akin to the Hoover Administration in 1930s Great Depression America, where authorities sought to deflate a balloon economy which had already unceremoniously burst. This so-called ‘inverse Keynesian compact’ took the opposing view of Keynesian stimulus spending (to jump start economic engines by pumping in cash, like ‘oil’, to get the economic ‘engines’ working again) by aiming to tackle crises by doing all you can fiscally to restore confidence.  In a panic, all you can really do with any assurance is combat collapsing recessionary tax revenues with deep cuts to public spending to meet avoid drowning in red ink. Of course, the question then arises – if the Hoover method prolonged the Great Depression, why are the troika insisting on this in the Irish, Greek and Portuguese cases?

Read the rest of this entry »