The global economy is wound up so tightly that if Greece goes snap, crackle and pop and causes something to break in European markets, there will be shit flying all over the place and a far more devastating GFC will begin.
Having read The Economist’s special report on international finance at the weekend, a speech made yesterday by Reserve Bank assistant governor Guy Debelle, the RBA’s latest board minutes and the Bloomberg and Financial Times stories on Greece over the past four days, and the book Lords of Finance, the bottom line is don’t think that the bad days of 2007-09 have gone away.
Greece could be the biggest challenge and many people seem to be missing the point about why the country is important.
The argument is that Greece is small, a tiddler in importance in Europe, and with only about 2.3% of the area’s GDP, default might hurt, but it won’t fatally wound Europe, let alone the world.
Rubbish, for a small economy whose collapse isn’t going to cause much pain, it has so far caused an awful lot of worry.
The RBA is watching Greece closely; it said in the February 2 minutes, released yesterday.
Spending continued to contract in many European economies. Members discussed this trend, which reflected weak income growth and rising household saving rates in some of the larger European economies. The latter appeared to reflect weak consumer sentiment, broader uncertainty about economic prospects, and — in some economies — concern about high public debt levels.
And Debelle, who overseas the bank’s financial markets operations, had this to say in his speech yesterday:
We are still yet to see the full impact of the weakness in the North Atlantic economies on the loans on the books of financial institutions. The bulk of the losses to date by these institutions have been write-downs in the value of securities held on their books.
While these write-downs have been absorbed, albeit with some difficulty and with substantial capital raisings, given the size of the output contraction, one would expect that we are not all that far advanced in the adverse credit cycle that normally accompanies recessions. For the North Atlantic economies, this was a big recession, which, combined with large falls in commercial and housing property prices, should result in large loan losses.
Greece is like the fall in US house prices and the US subprime crisis were in their early stages.
Remember how everyone said the US housing crisis wouldn’t correlate, won’t hurt other parts of the markets and the US economy. It’s not important was the reaction, even from Fed chairman Ben Bernanke … events proved otherwise and we had the GFC. But now US housing is back on the unwell list … and drifting … no one is taking that lightly any more.
Greece is drifting, as US housing drifted in 2006 and early 2007. There are shoals ahead, at least this time some can see the dangers posed by Greece and its insouciant attitude to debt, finance and competence.
The one thing in our favour is that Greece’s importance is being appreciated more and more.
The parallels with the US housing crisis are interesting. There are off-balance-sheet vehicles like SIVs, which were used extensively to house subprime and other related mortgages and securities. They were funded through leveraged vehicles to drive profits by banks, hedge funds and other investors. These vehicles (also called conduits) contributed heavily to the near collapse of major banks in the US (e.g. Citi) and Europe (UBS).
Goldman Sachs, BNP, Deutsche Bank and no doubt others are involved in similar arrangements with Greece, which minimised debt and maximised cash generation out of future income. (Italy, Portugal use these structures, according to the FT and others). Any other countries?
A question here is how many investors in these vehicles have tried to boost profits (and bonuses) by leveraging their investments with borrowed money in the belief that no one would let Greece default.
Moody’s is the only one of the big three international ratings groups that has Greece rated as an A class risk. S&P and Fitch have downgraded to the Bs. If Moody’s cuts its ratings, could that trigger a wholesale realignment in Greek and other European debt, just as downgrades on CDOs and subprime debt triggered the first and successive waves of the credit crunch?
Greece would be shut out of cheap money from the ECB and these complex securities and other loans would need to be “collaterallised”, or have money put up against them by the issuer (Greece) to protect the investors against losses. Would Greece have the money, or would it be like Bear Stearns or Lehman Brothers and be forced to go begging to the ECB or the European Union for help because it had no money?
So which banks are exposed to Greek debt of all kinds, from SIVs, sovereign to car, credit cards, housing and corporate (that’s besides the ECB, which is the biggest debtor). The estimate in the markets is that the 10 biggest US banks have $US156 billion in loans to Greece.
Hold the phones … what happens next?
Well, rescue Greece and you have to help the others, Italy, Portugal, Spain perhaps. Just as after Bear Stearns was bailed out in March 2008, the markets stalked other US banks of all sizes, toppling Lehman and forcing the US Government to bail out the rest, so the markets will stalk Portugal, Italy, Spain and other weaklings until they get another victim or bailout.
Moral hazard goes out the door, bank re-regulation and tightening market rules follows. Banks in Europe and the US again are under pressure (but not in Asia. But for how long?). Recession looms as the euro slumps, but rising values for the yen, the US dollar and Swiss franc threaten a new slump in the US, Japan and elsewhere.
The world’s second most important central bank, the European Central Bank is in the firing line, facing losses on its loans to Greece and no real way to defend the euro.
If Greece is rescued, Europe’s credibility takes a hit. Who believes Europe when Greece is described as a “one-off”, as it surely will?
China’s move away from the US dollar starts costing it small, but increasing losses; the Australian dollar comes under greater pressure, rising, falling, over the next year, putting further pressure on our export income.. (Leighton said the dollar cut $500 million from its revenues in the December half year, Fosters $83 million) … confidence falls, demand falls, the economy slows, unemployment starts rising, again.
It won’t take much. Australia’s current account deficit hauls into view.
The Swiss franc, which is already under enormous upward pressure, continues to rise, threatening UBS, Credit Suisse and the country’s financial stability; the yen rises further, deflation in Japan worsens from that already nasty 3% rate in the December quarter. The economy slows, retail sales slow, unemployment starts edging up, exports stall … recession, again.
Possibly the only thing that would relieve the pressure would be for China to float the currency, which would absorb much of the pressure from the dollar, yen and euro, and force the euro to depreciate to give Europe a chance to do something without destabilising itself.
But would China take that step to help the world.? It would reinforce the yuan as the world’s second or third major currency very quickly, but introduce volatility into China, to the concern of the Communist Party.
All that responsibility on a bunch of time-serving political hacks in Beijing. I can’t see them taking such a risk and inviting in the world, warts and all.
What would America give up to get China to float its currency?
So the global economy slides again as the US dollar rises sharply, followed by the yen with the Swiss franc. The Aussie dollar and other smaller currencies are buffeted, falling, rising as volatility increases and concern grows about the stability of the euro. Sterling is hit by conflicting pressures, but falls because the UK economy is tied so tightly to Europe.
Things are now wound up so tightly, that if Greece goes snap, crackle and pop and causes something to break in European markets, then there will be shit flying all over the place and the period from August 9, 2007 until now will look like a warm-up for the real thing.
So, on balance, back a eurofudge and the abandonment of moral hazard, but in a Germanic fashion (of not looking).
Take it from me, Greece matters. Why? Well, if it didn’t, it would have been left to sink, like Iceland.
The deadline is about May because Greece has 20 billion euros of various types of debt to redeem, and no visible means of support.