George Marshall turns in his grave

Unless you have been living under an economic rock you have probably heard by now that the Euro-elite is once again trying to convince the economic world that they have got a solution to the Greece driven debt crisis in Europe. A leaked draft statement from the summit can be found here.

The Guardian UK reports.

European leaders are poised to take a quantum leap to safeguard the future of the euro and rescue Greece from insolvency by turning the eurozone’s 15-month-old bailout fund into a much more ambitious instrument resembling an embryonic European monetary fund.

The deal being hatched at an emergency summit of eurozone leaders also looked certain to entail haircuts – losses – for Athens’ private investors, increasing the likelihood that Greece will become the first eurozone country deemed to be in some form of default on its sovereign debt.

A 15-point draft agreement being negotiated provided for a vast expansion in the role and powers of the €440bn bailout fund established in May last year. If finally agreed, the package would be the biggest eurozone move since it created the bailout fund, following months of acrimony and dithering that prompted bitter criticism of EU leaders, particularly Chancellor Angela Merkel of Germany.

Currently the fund can only be used as a last resort to rescue a eurozone country whose plight jeopardises the stability of the euro as a whole. Under the radical plan, the fund would be able to intervene on the secondary markets to buy up the bonds of struggling debtor countries, to take pre-emptive or “precautionary” action to nip a debt crisis in the bud by, for example, agreeing lines of credit, to supply loans to struggling eurozone countries which would then use the money to shore up and recapitalise their banks. Such aid would apply, unlike at present, to countries not already in bailout programmes.

The transformation of the bailout fund was directed not so much at Greece as at containing the threat of contagion to other vulnerable eurozone countries, an attempt to curb market uncertainty over the fate of the euro.

If agreed, the rules governing the use of the bailout fund would need to be rewritten, throwing up political problems mainly in Germany and the Netherlands. Senior German government sources, however, said the new regime was acceptable to Merkel who would push it through the German parliament.

As part of a new three-year rescue package for Greece, the summit appeared willing to countenance an effective Greek default, however temporarily and however “selectively” in order to satisfy German, Dutch and Finnish insistence that the country’s private creditors had to bear some of the costs of the new bailout by taking losses on their investments.

The draft statement did not put a figure on the investors’ losses, but said: “The financial sector has indicated its willingness to support Greece on a voluntary basis through a menu of options (bond exchange, roll-over, and buyback) at lending conditions comparable to public support with credit enhancement.”

…The eurozone loans would be provided at interest rates of 3.5%, two points lower than currently, while the maturity of loans to Greece would be more than doubled to at least 15 years. There was also good news for Ireland and Portugal whose borrowing costs for their eurozone bailouts would also fall to 3.5%.

As well as bailout funds, on top of the €110bn granted to Greece last year, the blueprint was also expected to entail a buyback of Greek bonds.

Taken together, the lower borrowing costs, longer maturities, investor losses, buyback and bailout money were all aimed at reducing Greece’s debt burden of €340bn, making the debt sustainable and improving the prospects of Greek economic and financial recovery.

On estimates from the European Commission, the package could cut Greece’s debt levels by €90bn.

The Eurozone has couched this as a “Marshall Plan” for Greece, after the post WWII plan of European reconstruction orchestrated by the US. In that plan, the US donated large sums of money to European nations for infrastructure reconstruction which the Europeans spent on US manufactures, and Bretton Woods pegged European currencies to the dollar at a competitive rate.

Although there is some “aid” for Greece in the form a selective default (debt forgiveness I suppose you might call it), there is no new infrastructure to boost producitivity and obviously no lowered currency. In other words, there is nothing new to rebuild Greece, which I would have thought was a prerequisite for the package to be vaguely Marshall-like.

Greece remains trapped in an overvalued currency that crushes its competiveness and must keep borrowing from Germany, probably to buy its manufactures. Worse, Marshall Plan 2.0 imposes austerity that will continue to lower its real industrial output and increase its overall debt position. European spin doctors need a history lesson.

In truth, Europe has taken another step towards fiscal unity, without taking a step towards fiscal unity. It looks as if the potential losses of the ECB and the banking system will be shifted to the EFSF by incentivising private entities to accept the deal with some sweeteners. Those sweeteners are explained in the press release from the IIF. The kicker can be found in the second last paragraph.

For instruments, 1, 2 and 3 the principal is fully collateralized by 30 year zero coupon AAA Bonds. For instrument 4, the principal is partially collateralized through funds held in an escrow account. All of the debt servicing risk on these new instruments, however, remains full Greek risk.

Basically, Marshall Plan 2.0 is an adjustment in financial instrumentation but no real solution. That is the big problem with this EFSF plan. Not to mention that before long, many of the EU nations that backstop the EFSF may well move into a position of actually needing the fund themselves if their economies continue to deteriorate. ( Some EFSF Q&A can be found here ).

The other issue is given the use of a structure like EFSF and not a Euro-bond, all nations still have their own debt issuing and fiscal sovereignty intact. This sounds fair, but it means there still exists a sovereign risk that nations who have now had their debts restructured will return to there old ways (if they ever left them in the first place).

A quick glance at the statement released this morning shows there is still way too much pixie dust and fairy wings flying around the offices of the Euro-elite, specifically points 6 and 9.

Fiscal consolidation and growth in the euro area:

6. All other Euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms. The Euro area Heads of States or Government fully support this determination as the credibility of all their sovereign signatures is a decisive element for ensuring financial stability in the Euro area as a whole.


9. All euro area Member States will adhere strictly to the agreed fiscal targets, improve competitiveness and address macro-economic imbalances. Deficits in all countries except those under a programme will be brought below 3% by 2013 at the latest. In this context, we welcome the budgetary package recently presented by the Italian government which will enable it to bring the deficit below 3% in 2012 and to achieve balance budget in 2014. We also welcome the ambitious reforms undertaken by Spain in the fiscal, financial and structural area. As a follow up to the results of bank stress tests, Member States will provide backstops to banks as appropriate.

These are fantasy. Greece itself is proof of what happens when a Euro bound uncompetitive country attempts austerity. Italy, Spain , Portugal and France are all in the same position, they just aren’t at the same crisis point as Greece.

Without a long term solution to deal with the competitiveness issues or a fiscal (transfer) union we will be back discussing the next bailout plan soon enough.

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  1. I was particulaly disheartened by the EFSF, when reading the ‘facts’ of it this morning. I’m not sure if your analysis makes me feel better, for not being alone in my musings, or worse, given what is likely to be the result of this folly.

  2. Germany should study their own history. The Marshall Plan (which benefited West Germany more than anybody else)only worked because the US dragged them kicking and screaming through a process of currency reform (which was really a controlled default).

    60 years later: Greece needs debt forgiveness or currency reform. Yet Germany continues to force a combination of austerity/high real exchange rate upon them and calls it a second Marshall Plan?

    The only way the PIIGS can possibly regain solvency inside the EMU is if Germany puts aside its inflation paranoia and adopts a higher inflation target.

    • MontagueCapulet

      Even if the Germans were willing to accept a 7% inflation rate, how would that help Spanish workers compete with German workers? You need to lower Spanish wages relative to German wages. German unions have been fairly willing to restrain wage increases during the last decade because they want to hold on to their jobs, I don’t think that is going to change.
      7% inflation in Spain would gradually inflate away Spanish debts – over the course of 20 years or more. But it would not do anything to help unemployment, except in the very long term.

      • Unemployment in the PIIGS is roughly twice what it is in Germany. If the ECB were able to free itself from the anti-inflation zealots at the Bundesbank, and credibly commit to a high inflation target (say 5%), inflation expectations and wage pressures would rise immediately in Germany but not in the PIIGS. This divergence in inflation expectations would see capital flow out of Germany and German output lose its competitive advantage. The Eurozone would rebalance, and growth would be sustainable.

        • MontagueCapulet

          My point was that wage pressures would NOT rise in Germany because German unions are willing to hold wages down to remain competitive and hang on to their jobs.
          I know the theory. But the theory is wrong. German unions won’t demand wage rises in the middle of a global depression. Do you think they won’t notice they are losing competitiveness? The thing about German union leaders is they actually understand enough economics to avoid pricing themselves out of a job. Your theory assumes that you are dealing with people who don’t understand cause and effect.

          • You can argue that a 5% ECB inflation target wouldn’t be credible (ie. nobody would believe that the ECB would allow 7% inflation in Germany over say a 4 year period), but you can’t argue that it would be credible yet nominal wages in Germany would continue to grow at 2% despite a tight labour market. That doesn’t make sense. By adopting a 5% target, the ECB would be signalling that it will keep monetary policy as loose as necessary to ensure that nominal wages in Germany grow at a faster rate. The unions are irrelevant.

  3. the only question now is whether Ireland or Spain will be the next participants in this “Marshall Plan”

  4. MontagueCapulet

    If the German leadership commits to throwing another trillion into the EFSF, despite the opposition of their people, won’t that just hasten the day that Germany’s debt reaches 100% of GDP? It’s 78% at the moment. Another 700 billion and they hit 100% of GDP. If the EFSF expands to a size that can handle Spain and Italy, what is Germany’s share of that? 300 billion maybe? If they keep going down this bailout route then Germany will end up with a 100% debt/GDP ration themselves.

    At some point the markets will get nervous about Eurobonds or German Bunds and the ECB will have to start doing QE themselves. Germany can’t assume everybody else’s debt indefinitely and still remain a AAA proposition.

    Mind you, it may take 5-10 years for the market to wake up to that fact. Look at Japan as an example.

  5. John Theodorou

    Assuming this package goes through, Greece gets to borrow at 3.5% while Spain struggles with huge debt rollovers at 6%? Irish not going to go gunning for bond haircuts of their own? Hmmm, speculators are going to have a field day testing the numerous weak spots of this agreement, which seems a day late and a dollar short to me.