Hidden Debt of Europe

[neddy]

The US does have an enormous national debt - indeed, it is higher than most other countries in the G10 as a share of GDP - but it's the UK that is struggling under the highest burden.
Source: Haver Analytics, Morgan Stanley Research

Greek crisis: going nowhere fast
By ABC's Alan Kohler
Posted February 22, 2012 12:35:36

The Greek bailout is merely an exercise in wishful thinking - first, that 95 per cent of bondholders will accept it and second that Greece's economy will return to growth sometime next year.

But it should get everyone past the crucial March 20 bond rollover, so Greece doesn't default then, and perhaps even slow down the capital flight from Greece, and buy the authorities some time to deal with Portugal, and then Ireland and then…

But it needs to be remembered that this is, and always has been, primarily a banking problem and that the world remains in the grip of sustained bank deleveraging, similar to what kept Japan in depression for more than 10 years in the '90s and beyond.

The crisis has its roots in two events in 1995: Bill Clinton's drive to increase home ownership and the creation of the euro, which was eventually introduced in 1999.

Clinton's 1995 document, "The National Homeownership Strategy: Partners in the American Dream", combined with the repeal of the Glass-Steagall Act of 1999 which unleashed the banks, and led directly to the explosion of subprime mortgage lending that brought American banks undone in 2007.

The creation of a single European currency, also between 1995 and 1999, led to that continent's own subprime bubble and bust - that is the explosion in lending to Greece, Portugal, Spain and Italy by French and German banks.

In 2008 the US government stepped in and recapitalised the American banks. It had the borrowing power to do it and despite a massive increase in its own sovereign debt and a subsequent credit rating downgrade, the US is still able to borrow readily from the bond markets. (It did muck up the rescue operation, however, by drawing the line at Lehman Brothers, thinking the investment bank didn't matter).

European banks took the single currency to mean uniform credit-worthiness and happily lent to sovereigns that they otherwise wouldn't have touched with a shillelagh.

Then in 2009-10, when US banks were deleveraging furiously, European banks stepped in and took up the slack because the true value of their euro sovereign loans, had not, at that point, become clear. According to UBS bank analysts, French banks in particular borrowed US dollars heavily in the interbank market to build up US dollar assets.

By 2010 they had become the world's biggest trade financiers, commodity trade financiers, and very big in shipping, aviation and commercial property.

As a result European banks entered 2012 in a precarious state: $US26 trillion assets were backed by just $US12 trillion in deposits and $US2 trillion in equity.

And now European governments, including Germany's, are in no position to recapitalise them, so they must try to prevent the default of their customers where possible and provide funding to keep them liquid while waiting for the markets to recover sufficiently to give them capital.

The European Central Bank's LTRO (long term repurchase operation) in December, and then again this month, is designed to remove the immediate risk of a Lehman-style European bank liquidity crisis but it provides no solution to the government debt issue.

The problem with LTRO is that the banks have to post collateral with the ECB to get the money, and when they do that two things happen: existing lenders are subordinated and the collateral gets a haircut (is reduced in value) by up to 65 per cent.

That means a troubled bank that needs LTRO money can quickly go through its entire balance sheet posting assets as collateral and still not get enough cash.

As for the latest Greek bailout, nobody seriously believes it will hold. The forecasts on which it is based assume GDP contraction of 1 per cent in 2013 and growth of 1.4 per cent in 2014, which means a return to growth sometime late next year.

This, to say the least, is a heroic assumption considering its GDP shrank at a horrible annual rate of 7 per cent in the December quarter and the government must now impose further budget cuts of €325 billion.

But even with these assumptions, Greece's debt only gets as low as 157 per cent of GDP before starting to rise again, and certainly not down to the required level of 120 per cent. And since private bondholders have been subordinated to government lenders (because the ECB has refused to take a haircut) they won't be back lending to Greece for a long time, if ever.

Greek GDP is now about €220 billion and falling. It has a persistent current account deficit, increasingly impoverished citizenry, massive capital flight and a bankrupt government. It is going nowhere fast.

The question for the world economy is whether European banks can be propped up long enough for the devaluing euro to work its magic on France, Germany, Netherlands, Austria and Belgium and allow the banks to recapitalise themselves.

And the problem is that to do it they need to deleverage, by $US3 trillion according to UBS analysts. That will offset the effect of the euro and act to depress the economy.

Increasing bank leverage produced the boom of 2002-2007; decreasing bank leverage is doing the opposite, and still has years to run.

 

[Seriusly]

QE by the US and the Eurozone will come to a head one day.

 

[philiprambo]

Its really good.Thanks a lot for sharing.

 

[singveld]

Although the immediate threat of defaulting on its debt looks to have been averted, Greece still faces years of economic struggle. Support is growing within the country for a return to the drachma and some European leaders have said the euro could survive a Greek exit. Radio 4's Chris Bowlby asks what would happen if Greece had to get a new currency?

The eurozone crisis is not just about political deals or high finance. It is also about confidence in the cash in people's pockets.

The euro was meant to symbolise a more united and stable continent for every eurozone citizen.

But if the single currency begins to fragment, if a country or countries reintroduce national currencies, everyone in the eurozone could be affected.

Haggling has continued over the terms of the latest Greek bailout, while political tension rises in Greece itself.

And as austerity bites deeper, few believe the overall crisis will be solved soon.

Plan B?
So there has been a very different, private policy conversation recently, full of angst, about what might happen if the eurozone cannot stay together.


Designing and printing a new currency would take about four months
"I've spoken to people about this in chancelleries and in parlours of power across Europe," says David Marsh, who has written a history of the euro, co-chairs a central banking think tank and stays in close contact with the euro's key players.

"I am convinced that there is a Plan B - people have told me that there is one," he adds. "But I don't know what it is and there's no reason why anybody should even think about making it open. It has got to be locked in a safe."

The reason for this secrecy?

Because when it comes to money, to the cash in people's pockets and bank accounts, then psychology lurks, and panic is always possible.

In Greece, there has already been a "slow run on the banks", reports political scientist Aristotle Kallis, as people take cash out of their accounts or send it abroad.

"They still feel that something will go horribly wrong - either Greece is going to move out of the euro or be kicked out of the euro."

And then, they fear, "there's going to be a devaluation of the new currency and all this money will be converted automatically to the new currency".

New currency
A government planning to leave the euro is likely to put in a discreet but urgent call to one of the top international currency printers - like the UK-based firm De La Rue.

It prints everything from the UK's pound sterling to the newest version of the currency in Iraq, the dinar.


Leaders like the Greek prime minister may not talk about a Plan B, but many are convinced there is one
The company will not comment on any plans it may have for Europe, but is clearly ready should opportunity arise.

So how long does it take to plan and introduce new notes and coins?

"I don't think you could do it much faster than four months," says Mark Crickett, one of De La Rue's consultants.

But a government could not commission and take delivery of a new currency without word leaking out and panic spreading.

It is much more likely that a withdrawal for the euro would be announced suddenly, and then there would be an interim period - those four months, say - during which a temporary national currency would be used.

Euro notes previously in circulation in a withdrawing country might be overprinted, or have special stickers added.

Rapid devaluation
But how would, say, Greek citizens react to the prospect of their euro cash being overprinted into rapidly devaluing new drachmas?

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Although the initial official exchange rate might be, say, one new drachma to one euro, economists expect a rapid devaluation of the new currency of 50% or more.

As capital controls within Greece would be likely to restrict Greeks' ability to convert euros to new currency at the devalued rate, those who have already been stockpiling old euros under their mattresses would probably head for the border.

In this kind of situation, says Mark Crickett, governments are left doing things like "sealing borders… to try to prevent the movement of currency".

And that interruption to the free movement of goods and people could call into question a country's membership of the European Union itself.

Any such action by one government would also prompt panic in other weaker eurozone countries, as citizens assumed their governments might follow suit.

Larry Hatheway, chief strategist of the UBS investment bank, has co-written one of the most extensive studies of what a eurozone break-up would mean.

"Imagine," he says, "that you are a Portuguese citizen, and someone walks into your office one day and says "Gee, did you hear the news? Greece just left the eurozone?"

"The logical response, it seems to me, would be to seriously consider whether to continue to keep your wealth, your assets, your money… in Portugal."

The 'unthinkable'
The political leaders' Plan B, some kind of firewall of finance and political commitment to prevent so-called contagion, should then emerge.

But could it counter the popular mood?

Attitudes to money across the eurozone could change radically after what Mr Hatheway calls "the unthinkable has happened".


How would the Greek public deal with the prospect of reverting to the drachma?
There would be many thousands of people trying to move euros across borders and trade them against rapidly depreciating new national currencies.

One very well-informed source told us the authorities in Germany were even discussing the possibility of the whole euro currency having to be redesigned and replaced if it was compromised by irregular trade.

And a prominent German newspaper, the Frankfurter Allgemeine Sonntagszeitung, has been recalling the Cold War when the Bundesbank kept an entire spare run of the West German currency, the D-mark, in storage - in case East Germany or the Soviet Union managed to compromise the circulating money with forgeries.

If the eurozone cannot hold together, the continent's cash may be about to return to a similar period of uncertainty, as people feel in their pockets the consequences of the politicians' failure.

 

[hmsg128]

Very informative, thanks.