Firstly, the restructuring of the Greek debt would be achieved by a nominal 50% reduction on the present value of sovereign bonds held by private investors. Without any agreement on the details of this "haircut", it is safe to say that the percentage is indicative, since there cannot be a final number without solving the math first. Assuming that a 50% is indeed the final outcome, the restructuring of the country's debt would not make the burden sustainable. This is made clear even from the most optimistic report of the troika in Greece, which predicts a 120% debt to GDP by 2020 should everything go as planned. Not only the ceteris paribus assumption is very brave amid these times where the unpredictable can happen at any moment; the amount of debt that Greece will be left with after this process will again be at unsustainable levels and will not be robust to a range of shocks (see Analysis of Greek debt sustainability based on the Troika report). The following graph is taken from the troika's report and shows the trajectory of the Greek debt assuming a 50% haircut on private investors.
Secondly, the plan for bank recapitalizations is ill designed. It expects from private banks to raise their Core Tier 1 capital to 9% by June 30 2012. Banks are expected to raise that amount of capital from the market. There are two basic ways this can be achieved: to draw it out of the real economy by diminishing loans, or to reduce the amount of assets. In either case, a simultaneous attempt of all banks to raise capital will have the effect of creating a credit crunch depriving the productive forces of the private sector from all the necessary liquidity. A contracting supply of money on a Euro-wide scale will have the effect of further retarding growth, hence making the crisis worse.
Thirdly, the latest deal included more bailouts. What has always been clear with the policy of expensive bailouts is that contagion is reinforced, since the debt burdens are in fact shared, with problems being reallocated, not solved. Throwing good money after bad is a policy that has no end to the cost.
Fourthly, the plan to leverage the EFSF, without any involvement of the ECB in the whole process is largely self-defeating. The only bazooka in the eurozone is the ECB, the EFSF is nothing more than a tower of cards. From my latest article on the matter here is the reason why that holds true:
The EFSF which is supposedly the mechanism through which the fall of states will be prevented is from the outset an unstable structure as it relies on the guarantees of all member-states, including those who are in need of funds. In effect Italy, Spain and the three countries that are under bail out programmes, are providing guarantees to their selves, which are only accepted thanks to the combined gold-platted AAA credit rating of France and Germany, the eurozone's two largest economies. The fundamental flaw in this structure is that France and Germany are in their selves in an unsafe position, since not even their own finances are very stable, either because of the exposure of their banks, which will indirectly bring the need for recapitalizations that have the effect of increasing public debts, or because of the burdens they carry with every country coming to the need of the EFSF, since those are the ones who provide the bulk of the funds.Adding to all of the above, the Greek Prime Minister announced that he will put the new bailout to a referendum, implying that Greece is closer to a disorderly default than ever before. The shock that this announcement caused is a proof of the systemic nature of the crisis and how a disorderly default of Greece will bring down the whole system in a way that would be far worse than that of Lehman Brothers.
The Achilles Heel in the EFSF is exactly its dependence on the triple-A credit rating of its two biggest contributors. France in particular has a banking sector that is heavily exposed to the debts of the European South, effectively raising questions of the capacity of the country to cling on to its excellent credit rating. These doubts are further reinforced by (i) the deterioration of Italy and Spain, with Italy being forced to lend money from the markets at an exorbitant interest rate of more than 6%, implying that the area's third largest economy is making steps towards a bailout programme via the EFSF, (ii) the anemic growth in the whole euro area, which is to a large extend caused by the simultaneous fiscal austerity of all member-states, leading to a unique, euro-wide fallacy of composition, reinforced by the overall slowdown in the global economy. With respect to the latter, French President Sarkozy made reference to the need for further fiscal consolidation in his country, suggesting that the national economy will effectively enter a period of contraction. Understandably this setting, leads to a self-fulfilling path to depression, bringing down the whole system, unless some "Good Samaritan" (call me China) shows up. But a Good Samaritan will only show up, if the chances of saving the euro are also good, otherwise he will prefer to invest his capital in other ventures.
Tomorrow starts the meeting of the G20, where the systemic crisis of the euro will dominate the discussions. The outcomes of the meeting will tell whether the final nail will be planted in the coffin of the latest European package or whether some indeed comprehensive solution is delivered from the international community, since European leaders seem unable to provide it.
Article source: http://www.protesilaos.com/2011/11/on-new-greek-bailout-and-euro-package.html
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