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Further Thoughts on the Lack of Greek Panic

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In my previous entry, I wondered about why there wasn't a banking panic going on in Greek.  However, my conclusion is rather unsatisfactory - essentially that there isn't a panic because your average Greek isn't panicking, yet.

Upon further reflection, I believe I know why the average Greek isn't panicking - and interestingly enough, it's the exactly same reason he should be panicking.

We got where we are today because the average Greek voted out the two parties that were cutting government spending in an attempt to keep Greece in the Euro.  Much like the average American voter (who wants to cut spending, increase services, cut taxes and balance the budget) the average Greek wants things that are mutually incompatible:  To increase government spending, balance the budget, and remain in the Euro.  He probably also wants to cut taxes, too, but I haven't read that, specifically.

Consequently, it's expected that a majority of Greeks will vote for SYRIZA, "The Coalition of the Radical Left", which is saying, "we can spend more money and stay in the Euro".  I believe the plan for this is to loudly point out to the rest of Europe that, if the rest of Europe stops giving Greece money, Greece will simply default on all the previous loans they've gotten, and anyway, it'll hurt the rest of Europe if the Euro is seen as unstable, so the Euro needs Greece more than Greece needs the Euro.  All of which may be true, but is unlikely to make the rest of Europe sympathetic with Greece. Helping out your brother-in-law who lost his job is one thing; it's quite another when he starts making threats to break your china if you tell him he has to start looking for a job.

The reason the average Greek is going to vote for SYRIZA is because he thinks it means Greece won't leave the Euro.  If Greece won't leave the Euro, why should he be worried about his money deposited in Greek banks in Euros?  If he thought SYRIZA's election put Greece at risk of leaving the Euro - he'd vote for another party. If he did that...there would be much less need to panic about Euros in Greek banks.

This seems to suggest that panic won't happen in Greece until well after the elections. The question is, to what extent is a SYRIZA election going to finally give the rest of Europe the backbone to say "Enough is enough"? In the past, they've been remarkably good about kicking the can down the road - it's possible to imagine them saying "well, we'll let you slide on your targets for six months out of respect for democracy", and just keep allowing this thing to not reach a resolution. It seems Greece isn't going to voluntarily leave the Euro - they're going to have to be kicked out, and we're still some time from that happening.

What's Going on in Greece?

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I predicted the end of the Euro back in November, a bit prematurely. However, as the worm continues to turn in Greece, it is becoming more and more obvious that (at least) Greece will leave the Euro. The messy details of what happens are rather terrifying, when you think about how Greece, tactically, is going to have to redenominate all of the Euros on deposit into Drachmas.

If I lived in Greece, I've thought for a while that I'd've taken my Euros out of the bank, completely, and tried to place them somewhere else.  At least in a bank in another Eurozone country - but if you believe Greece is about to leave the Euro, you also believe the Euro is about to decline in value, so as long as you're moving it, why not to a US bank?

But, as much as there have been stories in the past week about a "Greek Bank Run" on the order of a million or so Euros a day, there have been absolutely no stories about panics - crowds standing outside banks demanding their money and not getting it.

This has puzzled me, but I think I have thought it out. The money leaving Greece right now are the people who are paying attention, and relatively savvy.  They're just doing electronic transfers - ordering the banks to make changes to entries on a spreadsheet, in essence.  The banks could conceivably do this until their assets are zero, and it would be relatively orderly.

The problem is that at some point the average citizen - Iōséph Retsina - is going to realize that, next week, his Euros are going to turn into Drachmas, probably.  And, if that's going to happen, he needs to get to the bank with a sack, right now, and withdraw everything. When everyone has that same realization at the same time, then there will be a panic.

What happens then will be interesting.  They may still not have a government to take care of this problem.  What they'll need to do at that point is close the banks, freeze withdrawals and shift to the Drachma, immediately.  Will the "technocratic" caretaker government be able to accomplish that?

The End of the Euro

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It has been clear to me for many months (since at least June) that the Euro as we know it is at an end.  Some people are now optimistic that it will "only" result in a northern-Europe Euro zone, but I believe even that is highly unlikely as "bond vigilantes" descend to pick the carcass clean.

While this (relatively) slow-motion train wreck has already been well-described in the media, it's instructive for us to view as a preview to our own future.

A traditional (if imperfect) measure of a country's debt-related economic health is the debt:GDP ratio.  In other words, the total debt outstanding compared to the total value created by that economy in a given year.  It's easy to imagine a similar number for people - your total outstanding (unsecured) debt to your annual income.

The conventional wisdom is that a country whose total debt is less than 100% of its annual GDP is still in basically decent financial shape.  The further you get above that line, the more nervous investors (and ratings agencies) get.  There's no hard-and-fast rule of when there's a problem.  A stable country with a very high ratio (Japan has nearly 200%!) can be considered a fairly safe investment, while a less-sober country (*cough*Italy*cough*) can be in trouble with one as small as 120%.  Also important are rates of change of debt; growth of GDP; signaling by central banks; and many other factors.

Two key principles in these sorts of situations are:

  1. Perception is reality.  As long as people expect you to succeed, you can run very high debts.  The problem is, as soon as they begin to suspect that you'll fail, interest rates rise on the money you have to raise.  Even if you're no longer running up new debts, the old bonds mature and have to be paid off.  If you owe, say, $2.2T in debt, and have a balanced budget (are borrowing no more to keep your spending going), and your average interest rate is 3%, you're spending $66B in interest payments.  However, as those bonds mature, you have to pay them off, probably to the tune of at least hundreds of billions per year.  That money has to come from somewhere, so you have to "roll over" that debt.  If investors become worried that you're in financial difficulty, you'll have to pay higher interest rates on the new bonds.  If that goes to (say) 7%, you're now spending $154B in interest a year - and you're no longer in primary balance on your budget, and need to borrow even more to pay the interest on the new debt. Of course, that new borrowing will also be at a higher rate...
  2. This will be completely fine right up until the moment it isn't.  This stuff doesn't slowly get worse over a decade; it's fine and no one can see a problem, and then all of the sudden (in historical terms) it's a five-alarm fire and it's all over.
It's time to pull the fire alarm.

The Euro Zone is a bunch of mostly-autonomous governments who have decided to have a central bank and a common currency.  However, they each are individually able to borrow money.  Which, a number of them have done with great enthusiasm.  In theory, there were supposed to be limits on how much each country could borrow, but the reality has been that those limits have no real teeth, and they've been routinely flouted.

As Buffet said, "It's only when the tide goes out that you learn who's been swimming naked".  As the global economy faltered, the sharks began to circle.  Europe is now made up of a "core" - France and Germany and some other northern European countries whose debt is no more than about 80% of their GDP; and a "periphery" of southern countries that have ratios of 90%, 100%, 120%.

Six months ago the view was that the "periphery" was made up mostly of small countries, economically - Portugal, Greece, Spain, those sorts of places.  Clearly, if things got too bad, France and Germany would simply step in, pay the overage on their debts, and everything would be basically OK.  Sure, those countries would have to cut their budgets substantially as a term of it, and that would be unpleasant for them, but, it's not a global crisis.

Then, two things happened.  The first is that Germany made it absolutely clear that they weren't interested in being on the hook for an infinite amount of other people's loans.  They were, in other words, not interested in borrowing money to pay off other countries' debts, so those countries could have higher standards of living while Germany had higher taxes.  On the face of it, that seems like a reasonable position, but it is likely to cause Germany long-term harm as the Eurozone falls apart.  The second is that, suddenly (and perhaps in consequence of this), it turned out that one of the countries in real trouble was Italy.  Italy has the 8th largest economy in the world; and the 3rd largest in Europe.  Germany probably couldn't bail Italy out if it wanted to.  As a number of commentators have noted, it's "too big to fail, and too big to bail."

It has been quite amusing to read the European editorialists who pronounce "The European Central Bank [ECB] simply must do..." and then go on to lay out a list of actions that the ECB has already very explicitly said it is not going to take, because it would require German support that doesn't exist.

Now.  It's important to freeze the frame, here - in mid-October, 2011.  This crisis is, in principle, easy to fix.  Italy, Greece, Portugal, Spain, etc. simply need to trim their budgets, and/or raise taxes.  If they can bring their government spending into line, with a bit of a surplus to pay down the debt, they'll be able to send a credible signal to the bond market that they're getting their houses in order, and they're still good investment risks.  Simultaneously, Germany, France and the rest of the (relatively) solvent Eurozone simply have to say, "We are confident that our southern neighbors will put their houses in order.  So confident that we'll happily guarantee any bond they issue."

The incentives to get this right are enormous.  Unfortunately, they are not directed at the correct people:  Politicians. The core countries' electorates have made it clear that, damn the consequences, they are not spending their hard-earned dollars bailing out the profligate periphery.   The peripheries' electorates, meanwhile, have made it clear that, damn the consequences, they are not giving up their early retirements and extensive social safety nets just because those snooty northern Europeans say so.  "Who do those Germans think they are, trying to rule all of Europe from Berlin?" 

Politicians respond to those incentives until it is absolutely impossible not to.  For the periphery, that means when it becomes impossible to borrow new money, and it becomes necessary to finally do something.  The "something", however, will be to leave the Euro and go to their own currency so that they may print it with abandon and buy another couple of years.  That will then be the death knell for the Euro, however, as it will cause a domino run of bank runs as progressively "stronger" economies see mobile capital take flight to safer quarters.

My prediction for Europe?  Some periphery government will be unable to raise new money to roll over debt - which could be very soon indeed, perhaps before the end of the year and probably before the end of January - and will need to leave the Eurozone.  When it does so, it will destroy the Euro, completely - there will be no northern Euro, because the bond vigilantes will eventually set their sights on France.  Perception is reality, and that perceived vulnerability will become an actual one, and the currency union will shatter.

The effects here will be larger than most expect, because their banks are here and our banks are there.  Both of them will suddenly find all their Euro holdings to be of unknown risk (i.e., "junk"), and will be unable to meet reserve requirements.  There will be a bloodbath as these assets are unloaded.

All of those banks will need to park all of those assets, somewhere.

The only logical choice us US Treasuries.
In the long run, that is a disaster for us.

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