Greek Air Force motto: "We Do Our Part"

The Greek Air Force (no jokes please) is now on strike. 

A former (Spanish) colleague of mine at Moody's used to divide countries into two categories: serious and unserious. When someone wanted to upgrade an Argentina, he would say "They are not a serious country." 

Well, I don't think that there is any military in the world that has ever gone on strike (although it is true that certain unserious European militaries are unionized, but "peace is their profession").

So Greece now suggests that there should be three country categories instead of two: serious, unserious, and Hellenic. 

The Dow can't ignore Europe

I don't think that the American stock market (Mr. Dow) has incorporated the full import of the European financial crisis. 

Worst case, we are looking at a wave of sovereign defaults, a collapse of a series of government bond markets, instantaneous fiscal consolidation, deflation, and sharp decline in nominal and real GDP (over there, and I don't just mean Club Med, I mean the EU). 

Given globalization, as Japan remains becalmed, China slows, and Europe tanks, it's awfully hard to be bullish on anything but US Treasuries. I really don't see how gold benefits from deflation--that is a correction waiting to happen. (We could easily see gold go below $1000.)

 I see a big global selloff that will get the Dow Dow below 10,000. I felt the same way in September of 2007, but back then I believed that big rate cuts would fully offset the subprime crisis (because I didn't understand that we were facing a national secular deleveraging). This time, there is no Fed for Europe (well, there is, but it's brain dead). 

So what is the bull case for global growth? I'd bet double dip 75, growth 25.

Europe is to big to fail...but

It is now obvious that Southern Europe is too big to fail. But it is not clear exactly who is supposed to fund the bailout. 

First of all, Germany can't guarantee all of the sovereign bank debt in the EU, and Brussels itself has no financial resources whatsoever. The EU is a club, not a country.

So who is the lender of last resort for Spain and Italy? 

Well, it's not the IMF. The IMF has limited resources. It can come up with packages in the $50 billion range for large countries, but this is too small for a country like Spain. The IMF has been a big help in the Baltics, but now we're talking about real countries.

As I have said before, the ECB has a EUR 2 trillion balance sheet. It is big enough, but politically, the Germans are not going to turn the ECB into a development bank without a fight. And they have a veto.

Which leads us back to the IMF. It is in everyone's interest that Europe does not have a wave of sovereign (and bank) defaults, plunging the world into an unthinkable crisis. Therefore, Greece has morphed from a eurozone crisis to a global crisis which includes the US, Japan, and China. 

I think it is necessary for the IMF to be dramatically recapitalized, and for it to access the debt markets like the World Bank. It needs a trillion dollar balance sheet. Simultaneously, Europe needs a regional IMF with serious resources as well. But time is of the essence.

Europe's Plan A is to bridge Greece into 2011 and to pray to the eurogods that Spain, Portugal and Ireland retain market access (doubtful). If that doesn't work, time is very tight, while an IMF recap and the creation of an EMF simply can't happen quickly. 

Before this is over, the IMF will be bigger and Europe will probably have an EMF. But not soon enough to forestall a series of crackups that could make Lehman look like a fender-bender.

Investment conclusion: good for Treasuries, the dollar, the yen. Bad for global equities, the euro, and any other investment that begins with the letters eur. Probably bad for sterling as well (they're in Europe).

Return of the drachma?

Readers will note that I think Greece will default. In a previous post I wondered whether they would also repudiate their external debt.

But there is a second option, which would be to exit the euro and unilaterally redenominate its debt (and all domestic debt) into drachma. This doesn't avoid default, but it does get Greece back to the status quo ante bellum, with monetary sovereignty and the freedom to inflate away its problems. 

Of course there is also a third option: default, repudiate, and redenominate. Argentina did this in 2001 and it worked.

Carl Levin and the Wall Street witchhunt

Let me get this straight. Jimmy Cayne and Dick Fuld are bad people because they lost billions and drove their firms over the cliff. I get this. If you are a Wall Street CEO you are supposed to hedge your bets, take prudent risks, make money and remain solvent.

But now I learn that Lloyd Blankfein is a bad person because he...hedged his bets, took prudent risks, made money and remained solvent. He repaid his TARP money with interest, and the government made a nice profit on the warrants they took on Goldman stock. 

His other crime is "profiting from the financial collapse". If this is a crime, then I guess Cayne, Fuld, Pandit, O'Neal and the rest are heroes because they lost billions during the collapse. I don't want to be rude, but does Carl Levin have even a clue?

Can the ECB bail out Southern Europe?

Unlike the Fed, the ECB does not have a growth or stability mandate. The hawkish Germans insisted that its charter focus exclusively on price stability. To my knowledge there are no doves on the ECB's board. 


But despite this, would it be prudent for the ECB to stand idly by while the dominoes fall in Southern Europe? If the contagion spreads to Portugal, Spain, Italy and Ireland, eurozone nominal GDP will fall,  prices will fall, and the euro will collapse. 


Bernanke, speaking of the Great Depression, famously said "We [the Fed] did it. It was our fault." Does Trichet want a European collapse to be his historical legacy?

Today's FT:

“We have gone past the point of no return,” said Jacques Cailloux, chief Europe economist at the Royal Bank of Scotland.“There is a complete loss of confidence. The bond markets are in disintegration and it is getting worse every day. The ECB has been side-lined in the Greek crisis so far but do you allow a bond crash in your region if you are the lender-of-last resort? They may have to act as contagion spreads to larger countries such as Italy. We started to see the first glimpse of that today.”

Mr Cailloux said the ECB should resort to its “nuclear option” of intervening directly in the markets to purchase government bonds.

This is prohibited in normal times under the EU Treaties but the bank can buy a wide range of assets under its “structural operations” mandate in times of systemic crisis, theoretically in unlimited quantities.

Mr Cailloux added: “This feels like the banking crisis in late 2008 post-Lehman, though it has not yet spread to other asset classes. The ECB will have to act it if does.”

I would add that the consolidated assets of the ECB and its member central banks is EUR 2 trillion, which should leave considerable room for offsetting asset sales in order to sterilize the monetary impact.

The debt market gives up on Greece

The debt markets are closing for Greece as it sinks in that its debt trajectory is unsustainable, whether or not it receives the EU/IMF rescue package. The FT reports today: 

Greek two-year bond yields jumped more than 3 percentage points to more than 18 per cent Wednesday morning amid growing nervousness about the state of the country’s deteriorating public finances. 

Greek two-year bond yields are now the highest in the world, more than even the weakest emerging market economies such as Argentina and Venezuela. 

The extra premium Greece must now pay over Germany, Europe’s benchmark economy, for two-year debt is more than 17 per cent, an unsustainable level. 

Gary Jenkins, head of fixed-income research at Evolution, said: “Greece cannot afford to pay yields this high as the interest rate charges would be so great, the country’s public debt would continue to rise until the economy collapsed.” 

Greek 10-year yields also rose more than a percentage point to 11.034 per cent.

"What's the phone number for Europe?"

Henry Kissinger, who I guess was a eurosceptic, once famously asked when someone mentioned Europe, "Oh, what's the phone number for Europe?" That was 35 years ago. There still isn't a phone number for Europe, as Gideon Rachman of the FT explains below (3/26/10). (And dollars to doughnuts, neither Obama nor Biden have a clue who these two guys are.)

Barroso versus Van Rompuy

At European summits, it is easy to get the mistaken impression that the arguments are all about finding the correct policies or defending national interests. I suppose, sometimes, that is the case. But more often that not, it seems to come down to personality politics. I was struggling earlier today to understand why the French had been so reluctant to involve the IMF in the putative rescue of Greece. 

In my innocence, I thought it might have something to do with a French preference for a “European solution”. But then a French colleague explained to me. It’s simply that Nicolas Sarkozy sees Dominique Strauss-Kahn, the head of theIMF, as a potential rival in the next French presidential election. So he doesn’t want to agree to anything that might make Strauss-Kahn look good.

There is a similar ludicrous jostling going on between José Manuel Barroso, the president of the European Commission, and Herman Van Rompuy, the first appointee to the new post of president of the European Council. In theory, the two men work closely together. In practice, they are shaping up as bitter rivals. 

So, after today’s European summit, aides to the two presidents were busily trying to round up journalists for rival briefings - as each man jostled to show that he spoke for Europe. Now I am at the Brussels Forum of the German Marshall Fund, which is a big transatlantic conference. Barroso is speaking downstairs as I type. Then, over dinner, we get a speech by Van Rompuy. Sparkling stuff, in both cases, I’m sure.

Do these guys have any idea how ridiculous this makes them look? I suspect they probably do - they just can’t help themselves. In the lobby of the conference hotel, I just bumped into some official Americans who had been to see senior people at the commission. They had delicately raised the question of which of the two European “presidents” would represent the EU at future international summits. 

“Oh that’s all settled,” they were told, “they’re both going.” With enormous self-restraint, the Americans apparently refrained from laughing out loud, or banging their heads against the wall. Meanwhile European officials still maintain, with a straight face, that the Lisbon Treaty has “simplified” Europe’s structures.

When will Germany leave the euro?

It will be hard for Southern Europe to leave the euro because this can only be done by simultaneous default and loss of market access (a future of grindingly balanced budgets, or Latin American economic policy). Their Ruritanian currencies would plummet against the euro (in which their debt is denominated). In the end, they will have to leave the euro, but it will be very ugly.

But what stops the North from leaving? And, in particular, Germany. The Germans never wanted to give up the Mark in the first place. The Neue Deutche Mark, issued by the Neue Bundesbank, would become its old self again: the hardest major currency in the world. Germany's debt would still be denominated in euro, which is no problem if the DM is strong, as of course it will be. No more membership in a club that has lost its prestige (a prestige due in no small part to the ECB's location in Frankfurt). Germany could politely ask the ECB (whatever is left of it) to move to Brussels (or Palermo). 

I'm not joking. Right now there are a lot of Germans (in Merkel's party) who are looking at Germany's aging demographics and debt trajectories and asking: "Why do we have to consolidate the rest of Europe onto our balance sheet? Why will we have to save and cut back while the southerners party on? We have barely enough for our retirement, but not enough for every Mediterranean family."

The WWII guilt thing is getting a bit tired when that entire German generation is dead and Germany has been a model European citizen for over half a century. I doubt that many young Germans have any interest in perpetual "friend payments" to countries that have no self discipline and don't like Germans.

So it may be in everyone's interest to call a halt to monetary union. But what a mess! This unravelling will be much worse than getting out of the gold standard because that was an "gentleman's agreement", not a contract, and they didn't have entitlements in 1933.

Is the ECB broke?

The ECB will not disclose its exposure to Greek government collateral, but, according to Moody's, Greek banks had about EUR 70 billion in ECB funding at the end of March. 


That's an interesting number because the total equity in the consolidated Euro System is--wait for the answer!--EUR 70 billion. 

So when Greece defaults and Greek banks fail to post additional collateral, will the ECB decide to (a) disclose its exposure and (b) mark down its exposure? Could this make the ECB insolvent? Probably not.

Does it matter whether the ECB is solvent? The answer is: practically, no, unless third parties decide to care, which they shouldn't. The ECB has an unlimited ability to create money, whether it is solvent or not. 

But it would be ever so slightly embarrassing to the Jean-Claude Trichets of this world if the ECB needed to raise equity.