The debt situation is Greece is starting to spiral out of control. As capital flees the country, the debt discount mounts as the government desperately seeks to draw replacement funds. As the discount rises, the ability to service the increased interest declines. This is the debt death spiral. At some point the Greek government will offer to pay 30% interest on its notes … per day. It won’t be able to borrow at that rate; the rate itself will scare away the investors who know that such a return is ridiculous:
Funds flee Greece as Germany warns of “fatal” eurozone crisis.
By Ambrose Evans-Pritchard
Published: 8:14PM GMT 28 Jan 2010
Germany has triggered a near-panic flight from southern European debt markets by warning that there will be no EU bail-outs, even though it fears the region’s economic crisis has turned dangerous and could prove “fatal” for the entire eurozone.
The yield on 10-year Greek bonds blasted upwards by over 40 basis points to 7.15pc in a day of wild trading. Spreads over German Bunds reached almost four percentage points, by far the highest since Greece joined the euro, and close to levels that risk a self-feeding spiral. Contagion hit Portuguese, Spanish, Irish, and Italian bonds.
George Papandreou, the Greek premier, said in Davos that his country had been singled out as the weak link in a “attack on the eurozone” by speculators and political foes. “We are being targeted, particularly by those with an ulterior motive.”
Marc Ostwald, from Monument Securities, said the botched syndication of €8bn (£6.9bn) of Greek debt earlier this week has made matters worse. Many of the investors were “hot money” funds that bought on rumours that China was emerging as a buyer, offering them a chance for quick profit. When the China story was denied by Beijing and Athens, these funds rushed for the exit.
However, a key trigger yesterday was testimony in Germany’s parliament by economy minister Rainer Brüderle, who said there would be “no bail-outs” for struggling debtors and no move to a “European economic government”.
“A few European nations are exhibiting dangerous weaknesses. That could have fatal consequences for all countries in the eurozone,” he said. Despite the warning, he said each country must solve its own problems.
Brüderle does not remember European history. If he did he would recall the fate of Western Europe after banks denied a timely bailout to the Austrian Creditanstalt bank in 1831. Had the French – particulalrly – along with other European banks acted quickly, the crisis would have ended without significant damage. From Charles Kindleberger:
In May 1931 losses were still at 140 million schillings, and capital at 125 million plus disclosed reserves of 40 million for a total of 165 million. Under Austrian law, if a bank lost half its capital it had to “turn in its balance sheet,” or close down. In an effort to rescue the Creditanstalt, the government, the National Bank, and the House of Rothschild, the last with help of the Amsterdam branch, furnished 100 million, 30 million, and 22.5 million schillings, respectively. But the announcement of the support operation on May 11, 1931, started a run, partly foreign, partly Austrian…
By June 5 the credit [for the entire country] was exhausted and the Austrian National Bank requested another. Still under pressure, the bank raised its discount rate to 6 percent on June 8 and 7.5 percent on June 16. The new credit was arranged by the BIS, by June 14 this time, but subject to the condition that the Austrian government should obtain a two-to-three year loan abroad for 150 million schillings. At this point the French interposed the condition that the Austrian government should abandon the customs union with Germany. The Austrian government refused, and it fell…
The current Greek crisis is frighteningly similar; political prejudices that go back to the time of Homer have left the ECB and the economic powerhouses France and Germany frittering away valuable time. They deny both the problem and the needed steps to address it. Starting in 2008 while the world crisis was ripe would have put Greek finance in somewhat better order. This would have given Greece some breathing space. Investors would have been satisfied with assurance of euro support from the large nations. Timely assurance would have been better here than all the world’s assurance will be worth after Greek finance has frozen.
Keep in mind that Greece was experiencing civil disorder during 2008. This too, was swept under the rug.
The same rug that all the various credit/cash flow derivatives, commercial real estate, energy, oil, excessive defense spending, corruption and whatnot have been swept under. It’s pretty damned crowded under that rug!
As in 1931, the question whether to bail or not is not at issue, rather it is how late and how much? Inevitably Gernany/ECB will bail. They have to, there is no other choice. What is ridiculous is that the euro establishment has known from the very beginning that the stronger states would have to support the weaker ones. Doing what is inevitable is not bad policy, but putting off what is inevitable is.
Had the Union/Germany set up a ‘resolution trust’ for bad Greek debt and financed this in euros backed by German borrowing power, the Greeks would at least have access to low- priced credit. Two years ago the level of Greek debt was small. It is now enormous and swelling. A reason is the Greeks are borrowing from banks which have a lot of problems of their own.
Of course, setting up such a trust would have let the ‘poor Greek credit’ cat out of the bag. The international – and euro investors were aware of this cat, anyway!
An ‘out of the box’ rather than the out of the bag solution which would have Athens printing Drachmas against German bunds or Euro notes held in reserve, the Drachmas having a ‘reverse coupon’ depreciating them – rendering them worthless – over a short time – say 180 days. These would be convertible to- and from- euros but holders would need to spend them before they expired. This would at least keep currency in circulation and stimulate local business. A better way to collect taxes would allow the Greek government to earn funds to service the bunds/euro notes. Here’s an example from the Oil Drum:
On July 5th 1932, in the middle of the Great Depression, the Austrian town of Wörgl made economic history by introducing a remarkable complimentary currency. Wörgl was in trouble, and was prepared to try anything. Of its population of 4,500, a total of 1,500 people were without a job, and 200 families were penniless.
The mayor, Michael Unterguggenberger, had a long list of projects he wanted to accomplish, but there was hardly any money with which to carry them out. These included repaving the roads, streetlighting, extending water distribution across the whole town, and planting trees along the streets.
Rather than spending the 40,000 Austrian schillings in the town’s coffers to start these projects off, he deposited them in a local savings bank as a guarantee to back the issue of a type of complimentary currency known as ‘stamp scrip’. This requires a monthly stamp to be stuck on all the circulating notes for them to remain valid, and in Wörgl, the stamp amounted 1% of the each note’s value. The money raised was used to run a soup kitchen that fed 220 families.
Because nobody wanted to pay what was effectively a hoarding fee [technically known as ‘demurrage’ and often referred to as “negative interest”], everyone receiving the notes would spend them as fast as possible. The 40,000 schilling deposit allowed anyone to exchange scrip for 98 per cent of its value in schillings. This offer was rarely taken up though.
Of all the business in town, only the railway station and the post office refused to accept the local money. When people ran out of spending ideas, they would pay their taxes early using scrip, resulting in a huge increase in town revenues. Over the 13-month period the project ran, the council not only carried out all the intended works projects, but also built new houses, a reservoir, a ski jump, and a bridge. The people also used scrip to replant forests, in anticipation of the future cashflow they would receive from the trees.
The key to its success was the fast circulation of scrip within the local economy, 14 times higher than the schilling. This in turn increased trade, creating extra employment. At the time of the project, Wörgl was the only Austrian town to achieve full employment.
Six neighbouring villages copied the system successfully. The French Prime Minister, Eduoard Dalladier, made a special visit to see the ‘miracle of Wörgl’. In January 1933, the project was replicated in the neighbouring city of Kirchbuhl, and in June 1933, Unterguggenburger addressed a meeting with representatives from 170 different towns and villages. Two hundred Austrian townships were interested in adopting the idea.
Unterguggenberger was opposed to both communism and fascism, championing instead what he referred to as ‘economic freedom’. Therefore, it was deeply ironic that the Wörgl experiment was first branded ‘craziness’ by the monetary authorities, then a Communist idea, and some years later as a fascist one.
Rates on reserves equal to the euro lending rate would push currency/credit arbs out of the picture. A lower rate would also attract more capital as it would appear more secure. Currently, the speculators have most of the tools to attack Greek credit. Poor Greece has been let out to dry.
The most effective form or taxation would be those levied against wasteful energy consumption. The Greeks would have to invent businesses that did not rely on waste for cash flows. Having these flows in Drachmas would not hurt the euro but would take some of the pressure of euros held in Greece. The euro collateral for the drachmas could remain at the ECB as reserves … in plain sight. Similar regimes could be set up for Irish, Spanish and Italian local currencies.
Right now, the uncertainty is turning the flow into a flight.
Of course, the risk is that the countries would revert back to the old currencies and abandon the euro, but the euro without effective policy to support it is doomed anyway. A tariff on currency transfers along with the disintegrating nature of the local currencies would keep them safely ‘behind’ the euro security blanket.
Which blanket is and was the reason for the euro in the first place. A ‘fair weather’ common currency has no reason to exist.
Energy is at the heart of darkness for the Greek tragedy that is unfolding. Greek energy consumption mirrors consumption of other developed nations:
Both charts from the Energy Information Agency.
As can be seen, Greece neither has domestic reserves nor deployed alternatives. Consequently, it must import all of its petroleum from Saudi Arabia and other Middle Eastern suppliers. The Greeks are now subject to the same rise in energy cost as is the US and other nations. The consequence has been an increasing and inescapable tax on businesses and consumers. No wonder Greece is going broke. It cannot earn enough on its energy consumption to pay its energy bill.
What is taking place in Greece is the script for the other developed countries … this includes Great Britain, Germany and the US. All countries need to rein in energy consumption. This does not sidestep the bailout issue. Europe cannot afford for Greece to fail which would lead to Spain, Portugal, Italy and Ireland failing in short order. The issue is where to apply the liquidity bandage to staunch the deflationary bleeding most efficiently. Since Greece cannot be bailed out out last year, the second best solution is to bail tomorrow … if not then, soon!
Once the liquidity terror subsides, the heavy lifting of energy conservation and currency reform can begin.
This will put the European money establishment in an uncomfortable situation. For two years the ECB and the Euro- establishment has been sneering at the Yanks for their Bernanke Blunders and the circus- like Bernake Ponzi Money Laundry. The ECB now has to ‘do the Bernanke’ and reflate its paupers’ finance sectors! Not only that, regardless of what they do, the result will be the trashing of the euro. The Eurozone isn’t like America with its idle, TV- saturated masses who will grumble and do without. Money has to get into the hands of European citizens of there will be serious trouble in the streets!
Since the euro is not (really) a reserve currency there is no flight to quality toward the euro in this crisis. A Greek collapse destroys the euro with deflation as is happening now. An bailout leads to much higher energy prices – energy inflation as more euros pursue either less fuel or scarce dollars. The high energy prices are also deflationary. The cycle will push the dollar higher and oil priced in dollars lower, putting even more downward pressure on the euro.
On the other hand , the lower euro would theoretically support increased commerce … or would it? Not really because what the Eurozone exports is more and more energy consumption! This is what the rest of the world does not need.
The outcome is that Europe will be flooded with cheap euros leading to skyrocketing euro fuel costs. The Eurozone will have to buy dollars in order to be able to afford crude. Keep in mind, the reason for the Euro in the first place was to give European nations a means to import fuels without having to buy dollars first. So much for that idea …
Consumers will have to use less! Horrors!
Since the newly printed euros will speed toward the oil trade. A large euro bubble in crude will likely form; that is, if the bailout(s) are successful. How this is arbitraged will be interesting to observe. I suspect oil prices in dollars will continue to decline slightly while prices for diesel fuel rise out of sight. An outcome of this would be a second leg to the banking crisis as banks will have difficulty placing values on the assets they hold denominated in euros.
Alternatively, if the Greeks aren’t bailed, what money remains will flow out of Greece and the end will be IMF ‘rescue’ interference and austerity leaving the Greeks without the means to tolerate or escape it. There will be a deflationary crash in Greece that spreads to other ‘solvency challenged’ Euro- states. In this scenario, the end of the Euro would be swift and certain.
Expect to read about a bailout of Greece by Germany tomorrow at the latest …