Greece EU Future Doomed, Says Economist

While many economists attempt to affect a balanced approach to speculating on Greece’s future in the European Union (EU), Tim Duy believes the country’s economic future a fait accompli. Its pace of deterioration is too fast and key players in the EU and the European Central Bank have waited too long to take the action necessary to save it, and may even have waited too long to save the euro. It is known that Greece will have difficulty meeting its cash obligations in June and will be near-leaderless until elections are held in the middle of the month. By then, it will surely be too far gone to save with a bailout that any lender would find reasonable. For more on this continue reading the following article from Economist’s View. 

Tim Duy:

Greece is Running Out of Time, by Tim Duy: I have repeatedly described myself as a Euroskeptic. The current combination of politics and economics looks likely to at worst doom the Euro to failure, at best to commit the Continent to a deep and long-lasting recession. Moreover, the pace of deterioration in Greece, combined with an economic structure that seems completely at odds with much of the rest of Europe, seems to make a Grexit all but impossible.
That said, I am horrified at the ongoing willingness of European policymakers to still be playing chicken at this point. I assumed that my skepticism would ultimately be proved wrong as the European Central Bank would ultimately cave and effectively monetize national debt across the Eurozone, and that Germany would come to this conclusion as necessary to save the single currency that they have long-championed. That ultimately, the Eurozone would step up and take greater responsibility for this mess, understanding that while the Greeks have mismanaged their economy, they should never have been admitted to the Eurozone in the first place.
Instead, Europe situation is now akin to two or three trains running full-speed at one another, and by the time someone finally pulls on the brakes, it will be too late. By the time key actors step into action, irreparable damage will have been done
Consider that one of those trains, Greece, has no driver, nor will it until June 17 when fresh elections are held. Combine that with a deteriorating fiscal situation - believe it or not, it actually continues to get worse. From Bloomberg:

The level of funds in Greece’s state coffers has fallen below 1.5 billion euros ($1.9 billion), Imerisia reported, citing “reliable information.”
If the state doesn’t receive predicted revenue for the rest of this month, it will find it difficult to pay for social services, pensions and public-sector wages, the newspaper said.

This was confirmed by the outgoing leader:

Greece's outgoing Prime Minister Lucas Papademos has warned the country's political leaders the government may have difficulty in meeting its cash obligations as of the start of June, a Greek newspaper reported Monday.
In a note Papademos sent to Greek President Karolos Papoulias and discussed in Sunday's meetings between the president and party leaders on forming a coalition government, the prime minister said it is likely Greece will have significant difficulties in covering its cash payments in June, according to newspaper Ta Nea, citing unnamed sources from Papoulias' office

Now, further consider one of the proximate causes of the new fiscal shortfall:

Greece' s budget revenues have reportedly dropped by 10.2% in April compared to the same month in 2011, as daily Kathimerini reports quoting provisional figures the Finance Ministry is studying. The election period did nothing to help state receipts as the tax collection and monitoring mechanism traditionally relaxes ahead of polls, and did so again this year despite the crisis.

It has been said before, but is worth saying again - how did this economy pass the bar to Euro membership in the first place? If officially sanctioned tax avoidance remains in effect, and we have another month until the new elections, I can't imagine that the fiscal picture is going to do anything but go from bad to worse. Or from worse to as worse as it can get.
Given the deteriorating fiscal position, Greece will eventually need a larger bailout if it is to stay in the Euro. Simply put, if they can't pay their bills with Euros, they will need to issue their own currency. Deep in a piece on the failed efforts to collect property taxes via electricity bills, the FT brings us this from a "friendly trader":

When we talk about Greece “running out of money” in coming weeks/months, the combination of dire recession, plus non compliance in Revenue collection will speed the day that Civil Servants and suppliers are paid in IOU’s or “New Drachma” in the absence of any funding from the EU/IMF…

Once IOU's start circulating, the clock will start ticking. Either they get replaced soon with actual Euros, or they start trading as currency. In other words, time is growing very, very short to find a solution that keeps Greece in the Eurozone.
Meanwhile, is the final run on Greece's banks underway? From the Wall Street Journal:

Greek depositors withdrew €700 million ($898 million) from local banks Monday, the country's president said, as he warned that the situation facing Greece's lenders was very difficult.
In a transcript of remarks by President Karolos Papoulias to Greek political leaders that was released Tuesday, Mr. Papoulias said that withdrawals plus buy orders received by Greek banks for German bunds totalled some 800 million.

A bank run in the absence of a functioning government. Is there anyone ready to push the button on a bank holiday with capital controls? Or is this about to devolve into a free-for-all flight of capital?
Meanwhile, Germany and France are holding to the official line. From the FT:

“We want Greece to stay in the euro,” Ms Merkel said. “We know that the majority of people in Greece see that.”
The Greek government had also agreed on a rescue programme with the IMF and the EU after lengthy negotiations, she said. “I believe that memorandum must be respected.”

This ignores the small point that the last bailout was certain to fail from the start. The message remains that no one but Greece is making the decision to leave the Euro:

“We have to respect that there will be new elections in Greece,” she added. “We will make it clear that we want Greece to remain in the eurozone, and that is what the citizens are voting on.”

But out comes the unspecified carrot:

That meant fulfilling the commitments in the EU and IMF programme, she said, but added: “We will also give proposals to Greece to encourage growth.”
Mr Hollande went further, saying that “I hope that we can say to the Greeks that Europe is ready to add measures to help growth and support economic activity, so that there is a return to growth in Greece.”More carrot with stick would have been helpful two years ago. Now it is looking like too little, too late. And what kind of measures are these? Direct bilateral transfers from Germany, which would be helpful? Or more loans to add to those that Greece can not already afford?

In other news, in the wake of its two LTRO operations, the ECB is back to neglecting its role as lender of last resort. As a consequence, Spanish yields are now solidly back above 6%, with Italian yields in close pursuit. Apparently, investors are not convinced that the supposed firewalls are sufficient to control contagion. European policymakers have fallen short of the mark. Again.
Bottom Line: I don't see how European policymakers can be anything but terrified that this whole experiment is unraveling at a frightening pace. Yet they keep barreling ahead on this disastrous path, ensuring that things continue to get worse before they get better.

Update: Three more from Tim Duy:

Central Bank FAIL - ECB Edition: From the Wall Street Journal:

The steady outflow of deposits from Greek banks hasn't yet turned into a full-blown bank run, and the European Central Bank has nearly limitless capacity to provide banks with additional liquidity. But economists have long warned that a run on banks could develop if the population fears Greece's departure from the euro is imminent and that their savings would evaporate. A bank run could trigger the euro exit if it reaches a scale that forces Greek authorities to freeze bank accounts and print their own currency to keep the financial system alive.
What is more, if Greece fails to comply with the conditions of its bailouts, the ECB would likely cut off the liquidity support for its banks, a move that could cause the banking system's collapse.

It is simply unbelievable that at this point in history, more than 100 years after Bagehot's Lomberd Street, that we could consider that the European Central Bank will not only fail in its role as lender of last resort for the fiscal authority, but also fail in its role as lender of last resort to the banking system.  Yet here we are.
Failure to Communicate: Yet another amazing quote from the same Wall Street Journal article:

Greece's renewed turmoil is putting Europe's leaders in a difficult position. Many hoped that the Greek election would result in a national consensus to push forward with the deep spending cuts Greece's previous governments committed to as a condition of the rescues. Instead, voters used the ballot to express deep dissatisfaction with the measures.

Really?  Did European policymakers really believe that the Greek people would never grow tired of the endless austerity?  If so, this is simply sad, because virtually everyone else in the rest of world saw that the Greek people were being pushed over the edge.
Questionable Assumptions: From the Financial Times:

Ms Merkel defended her belief that the common currency was "not just a monetary project, but a political project". It meant that the member states of the eurozone shared a common responsibility. "People who have a common currency will never fight a war against each other," she said.

Isn't this just plain wrong?  When people with a common currency fight a war, we call it a civil war.  Not exactly without historical precedent.

 This article was republished with permission from Economist's View.

Eurozone Debt Deal Falters

Economist Tim Duy discusses the weaknesses in the debt deal designed to save the Eurozone, and explains why it was destined to fail. It appears Greek leaders were never comfortable with the parameters of the agreement formed by other European politicians last week, and holders of Greek bonds even less so. It appears bondholders are not as willing to take a 50% loss on investment as once though, and now Spain is showing further signs of weakness as its GDP grinds to a halt. Duy speculates that deal details that were expected to take a few months to iron out will now take much longer while the Eurozone sinks deeper into debt and the U.S. teeters on the edge of another full-blown recession. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Did The European Deal Just Collapse?, by Tim Duy: To be sure, I have been bearish on Europe. From last week:

I remain something of a Euroskeptic at this point. At best, I think the Europeans will be kicking the can down the road for a few months.

It turns out a "few months" might have been wildly optimistic. It was quickly evident that bond markets didn't show the same enthusiasm equity markets expressed for the supposed deal. That was huge red flag. The second red flag was the Bank of Spain announcing a stagnant 3Q GDP. From the Associated Press:

The Bank of Spain suggested that the flat growth calls into question the government's goal of reducing its deficit to 6 percent of GDP in 2011, from 9.2 percent last year...

...It said domestic demand fell because of lower government spending as a result of deficit-reducing austerity measures taken by regional governments and because of a moribund real estate market. Household and business spending posted small increases. Spain's economic woes stem largely from the collapse of a property bubble.

The Bank of Spain said there is still time to meet the deficit reduction target by the year's end but warned that fresh measures may be necessary.

Yes, you read that right...the Bank of Spain blamed missing deficit reduction targets on fiscal austerity and then suggests additional fiscal austerity as the solution. And as all nations in the Eurozone increasingly pursue fiscal austerity, we can only expect the nascent European recession to deepen. Eventually, the European public will have had enough of the downward spiral. How long will it be before Spain decides to aggressively push for a Greece solution of "voluntary" debt relief?

Finally, a lynchpin in the European debt deal - Greece - apparently isn't ready to abide by the terms of that deal. The public pressure is now too much. From the Financial Times:

Greece’s prime minister unexpectedly announced a referendum to approve a second EU bail-out deal for his austerity-hit country, less than a week after it was agreed with international creditors at a European Union summit...

...One senior EU official told the Financial Times that Mr Papandreou had appeared reticent about the components of the bail-out package during talks at last week’s summit of EU presidents and prime ministers but no one was prepared for the referendum announcement that came “like a bolt out of the blue...

...The vote would probably be held in January, when Greek bondholders were expected to sign up for a voluntary 50 per cent haircut being negotiated with the International Institute of Finance, wrapping up the new bail-out package. One Athens banker said: “This is a worrying decision by the prime minister. It could derail the whole process even before it’s properly started.”

Not only are the details of the grand European plan still in flux, but so are the broad brushstrokes! Clearly, the Greeks have just brought back into play all the uncertainty last week's summit was meant to dispel. It is not unreasonable to think the Greek electorate is more willing to technically default and start from scratch than their leaders. Indeed, shouldn't this be our baseline scenario?

Bottom Line: Last week's European Summit accomplished far less than even the reduced expectations going into last week. The cracks began appearing before the ink was dry. More worrisome is that the Greek leadership didn't even believe they were on board in the first place. Simply put, the world economy is no less fragile than it was a week ago. And in that fragility still lies the recession risk for a still struggling US economy.

This blog post was republished with permission from Economist's View.

European Leaders Continue Debt Negotiations

Tim Iacono provides a video clip rehashing the latest meeting between Eurozone leaders regarding how to solve the Greek debt crisis and wider concerns for the stability of the European currency union. Politicians have agreed the European Financial Stability Facility fund should be increased to $1.4 trillion to cover capital expenses that will be faced by banks and investors that are expected to take a as much as a 50% loss in a Greek bailout. The specific financial instrument that will facilitate this is still being debated, however, and one option may involve allowing China and Middle Eastern countries to buy into the debt. For more on this continue reading the following article from Tim Iacono.

It looks like they’ve agreed to something over in Europe, though it remains to be seen whether this deal will last any longer than any of the last half dozen or so agreements aimed at keeping the currency union from breaking apart.

Investors have reportedly agreed to take losses of 50 percent on Greek debt and French President Sarkozy told reporters that the EFSF bailout fund is about to be “leveraged up” to $1.4 trillion, the proverbial “bazooka” in the EU’s pocket. It looks like they’re on a roll…

This blog post was republished with permission from Tim Iacono.

Concerns Grow Over Spread Of Greece Debt Crisis

As concerns grow over the spread of Greece's debt crisis to other economies, Moses Kim discusses the risk of reverberations affecting the US economy. The debt crisis is already being felt in Portugal as it received a downgraded credit rating from Standard and Poor. See the following post from Expected Returns.

As stocks sell off and sovereign debt ratings drop, people are starting to realize how tenuous this economic recovery is. Debt crises rarely occur in isolation; in fact, they are quite "contagious." When the debt crisis spreads to the U.S., you will see some real fireworks. From Bloomberg:

Portugal had its credit rating cut two steps by Standard & Poor’s as contagion from Greece’s debt crisis spreads through the euro region.

S&P lowered its long-term local and foreign currency ratings to A- from A+, it said in a statement today. The outlook is negative, the company said.

The extra yield investors demand to hold Portuguese bonds over German bunds surged to 265 basis points today, the most since at least 1997, as the government struggles to convince investors it can cut its budget deficit. Portugal, whose economy has barely grown for a decade, had a shortfall of 9.4 percent of gross domestic product last year, the fourth-highest in the euro-region.

Portugal may have the fourth highest deficit to GDP ratio in Europe, but it lags the U.S, whose deficit to GDP ratio sits at 9.9%. With government spending increasing at a torrid pace, we're well on pace to surpass 10% this year. Of course all the headlines are focused on the problems in Europe, which is quite comical if you ask me.

Commodites are down across the board, including crude oil, which is down over 2% as we speak. But gold is mysteriously bucking the trend in commodities and is rising on the news of Portugal's debt downgrade.

Flight to quality, anyone?

This article has been republished from Moses Kim's blog, Expected Returns.