So, as predicted , Spain looks set to become the next Eurozone nation to fall. It’s 10 year yield hit 7.5% overnight, but more importantly the yield at the short end ramped up significantly. 2 yr yields are now sitting at 6.5%. These rates are clearly unsustainable and so, against previous and continuing denial, Spain looks set for some form of external help.
Turning to Greece, it appears that the country is coming ever closer to political disconnection from the rest of Europe as the taboo of a ‘grexit’ has disappeared:
New speculation of a Greek exit from the euro zone hit financial markets on Monday after the IMF and major creditors including Germany were reported to be intent on refusing further aid. German media commentators don’t see how Greece can avoid quitting the euro — and say Athens has mainly itself to blame.
Greece is most definitely to blame, but there is a lot of buck passing here because that in no way is the whole story.
When Greece joined the Euro, under dubious circumstances, it hooked itself into a currency regime that was incompatible with the country’s economy. Over the next decade the country’s real exchange rate worsened by 20% which slowly began to price them out of export markets and it boosted consumption of imports. By 2009 Greece had an ever-growing current account deficit in excess of 11% of GDP.
In October 2009, shortly after taking office, George Papandreou’s government announced that it had found major discrepancies between the reported and actual budget of his country. Within a month Greece became embroiled in a financial crisis that continues to this day.
The issues were initially met with denial by Greece and its European partners and you only have to go back to early 2010 to find doozies like this one:
Greece will not restructure its debt and will not need more cuts to achieve fiscal targets set in the emergency funding programme it agreed with the European Union and the IMF, its finance minister told a Sunday paper.
The debt-laden country has been offered a 110 billion euro ($134 billion) bailout to avoid defaulting on its debt and in return promised to cut the deficit by 11 percentage points of GDP and bring it below the EU’s cap of 3 percent by 2013.
So yes, I don’t think there is any doubt that Greece was to blame for creating its own problems, but that doesn’t mean that it is also to blame for what its problems became. This was in fact a structural issue with the whole of Europe that effected many countries because the economic architecture is set up so that the success of one nation comes at the expenses of others. Without the backstop of fiscal policy to counteract that monetary union’s imbalances it was only a matter of time before the divergence in competitiveness led to a crisis which Europe was completely unprepared for. As I stated back in March 2011 the political and economic structure of the Eurozone was a dangerous trap:
… it means that unless the southern European states ran large government deficits the populations of those countries would slowly be getting poorer in the absence of deflation. But the economic environment was never going to be supportive of deflation. National governments kept issuing bonds to cover the ever growing debt while the backing of the ECB was giving the false impression to foreign investors that Greece was as safe a Germany. So while Germany kept exporting into Europe other national governments kept spending to cover the difference. Those countries appeared safe and relatively cheap to foreigners so in rolled the capital causing asset driven speculation.
The whole framework is an economic trap that requires prudent economic management by national governments. However as we know from Australia, property developers and Real estate lobbies are very well politically connected, so once speculation took hold there was no way governments were going to implement policy to push against bubbles, even if the EU economic framework would have allowed them to. As soon as the EZ was formed the fuse was lit, it was inevitable that economic stupidity, political opportunistic behaviour and corruption was going to lead to a collapse. But the real problem was that no one seemed be aware that once it did collapse the EZ had no mechanism to deal with the fall out.
So here we are. The fuse was lit, the bomb went off and now EZ leaders simply don’t know how to deal with the problem
And this is where the policy response was no better than the problem it was trying to solve. As I have stated previously:
.. one of the fundamental problems in the Eurozone is competitiveness imbalances under the common currency. These imbalances, along with poorly regulated banking and basic financial stupidity, led to a huge build up of debt in many countries in Europe which eventually caused a crisis. In response to this crisis the leaders of the Eurozone have forced indebted countries to implemented highly deflationary economic policy which has, in a number of cases, made the competitiveness imbalance, and therefore the problem, even worse.
The catastrophic collapse of the Argentine economy in 2001–02 represents the failure of Argentine policymakers to take necessary corrective measures at a sufficiently early stage. The IMF on its part, supported by its major shareholders, also erred in failing to call an earlier halt to support for a strategy that, as implemented, was not sustainable. As the crisis deepened, the IMF was not able to engage the authorities in evolving an alternative strategy that might have helped mitigate the ultimate costs of the crisis, even though these would have been inevitably high.
…
The situation changed in 1998–99 when Argentina was hit by a series of adverse shocks, including the devaluation of the Brazilian real, a sharp re- duction in capital flows to emerging markets, a strengthening dollar, and a rise in international interest rates, which, taken together, led to a permanent decline in Argentina’s equilibrium real exchange rate.
These shocks would have been difficult enough to handle at any time, given the rigidity of the fixed exchange rate and the lack of downward flexibility in domestic wages and prices. As it happened, they came at a time when the fiscal situation had deteriorated steadily, with a continuous rise in the balance of public debt. What is worse, almost 90 percent of the debt was denominated in foreign currencies, raising doubts about Argentina’s debt servicing capacity and exacerbating the vulnerability to shifts in equilibrium real exchange rates. The resulting rise in sovereign spreads, in an environment where growth remained low, created highly unfavorable debt dynamics. The domestic political situation also con- tributed to how the crisis evolved, as the election- driven rise in public spending in 1998–99 added to fiscal fragility and the divisions in the coalition government that took office in late 1999 shook the confidence of domestic and international investors in Argentina’s ability to take difficult decisions.
….
The January 2001 program was therefore optimistic to begin with and, as it happened, the commitments made under the program were not fully implemented. In particular, it soon became evident that the fiscal targets would not be met. The willingness of the IMF to complete a review in May 2001 despite Argentina’s noncompliance with fiscal targets, when there were indications that the catalytic ap-proach had failed, allowed the authorities to pursue a series of desperate and unorthodox measures to “gamble for redemption.”
Many in the IMF internally expressed disagreement with those measures but, in public, the IMF supported Argentina, fearing that doing otherwise would mean an immediate explosion of the crisis. A further augmentation of the SBA was approved in September 2001, accompanied by ineffective and conceptually flawed efforts to promote a voluntary debt restructuring without offering a sustainable policy framework. This did not restore market confidence and only allowed the crisis to drag on.
In retrospect, the IMF’s efforts at crisis management suffered from a serious weakness. At each decision point in 2000–01, the IMF’s management and Executive Board considered the costs of a switch, from a less sustainable policy environment to one that would be more sustainable in the long run but that would involve massive disturbances in the short run, to be too high, and chose to buy time until conditions improved. The costs of an exit would have been very large indeed, regardless of when it was made. As it turned out, the ultimate costs probably rose, as Argentina’s credibility was lost, international reserves declined further, more public debt was forced on the banking sector and more deposits were withdrawn, and the country’s debt to the IMF expanded against the background of falling output.
.. he saw few parallels between the plight of Greece and fellow debt-mired country Spain, for which the eurogroup approved a bank aid package of up to 100 billion euros ($122 billion) on Friday.
“The causes for the crises in both countries are completely different. Spain’s economy is much more competitive and has a different structure. The country will get back on its feet quickly,” he said.