As I have explained constantly over the past 18 months, 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.
That is the reason I have been so vocal in reminding everyone that the underlying problems still exists, because while the headlines keep talking about the “bailouts” and “austerity” and the leaders of Europe are constantly fixated on dealing with only the symptoms of the problem, the problem itself grows ever worse :
Greece and its private-sector creditors were set to resume negotiations in Athens later Thursday to restructure the country’s towering debt load, a process accompanied by concerns that Greece’s funding needs might be bigger than originally thought.
Euro-zone officials in October agreed to provide Greece with debt relief with a planned package to ensure that its debt equals to no more than 120% of its gross domestic product in 2020. Since then, further deterioration in the Greek economy and a budget deficit that has widened to nearly 10% of GDP could put those projections in doubt. The new debt-sustainability study, due for release by the European Union and the International Monetary Fund once talks with the private creditors are completed, might require a rethink on the funding Greece will need to be able to service its debt for the rest of the decade.
Greece’s debt restructuring is planned to take the form of a bond exchange in which creditors holding some EUR200 billion in Greek bonds swap their securities for new instruments with half the face value. The key sticking point is how much interest new bonds should pay. Germany and the IMF have led calls for private-sector bondholders to accept a coupon of well under 4%, while investors so far have insisted on 4% on the new bonds as a minimum.
The IMF and the stronger euro-zone countries are reluctant to permit high coupons, in part because they would have to lend Greece the money to pay them and in part because high interest burdens make it less likely the country can get its debt under control.
That leaves two options: pressure private-sector bondholders to accept more losses, or accept that other euro-zone countries and the IMF will have to kick in more support.
Is this a surprise. No! As I said back in March 2011:
Greece was always going to be in trouble as soon as there was an economic downturn in Europe because they are trapped between the domestic policies of Germany and the inflexibility of the monetary system they signed up to when they joined the Euro. The austerity package is failing, but it is only failing to fix the symptoms. Without currency deflation the only possible outcome is lower wages for the Greeks, which will inevitably lead to default on loans, the exact thing the Germans and French are attempting to stop happening.
Against all denials from European leaders over the last 2 years that this would never be allowed to occur, here we are. The IMF and the OECD are now requesting that the ECB take a loss on its holdings of Greek debt but at this point the Central bank appears to be unimpressed with the idea:
The European Central Bank has ruled out taking voluntary losses on its Greek bond holdings but is now debating how it would handle any forced losses and whether to explore legal options to avoid such a hit.
And so, once again, while Europe fiddles around trying to workout what to do about a flare up in a symptom, the disease continues to spread. Portugal now appears to displaying all of the same signs of denial that Greece did about 12 months ago while also displaying similar signs of pain:
Portugal needs an additional 30 billion euros in EU/IMF rescue funds to solve a credit crunch in the recession-hit economy and may have to negotiate an extension for its bailout, the head of the country’s industry confederation said on Wednesday.
Antonio Saraiva, the leader of the influential lobby group with vast collective bargaining powers, told Reuters the 78-billion-euro bailout that runs through 2013 did not take into account massive debts by inefficient, loss-making public companies, especially in the transport sector.
Due to Portugal’s debt crisis, foreign banks have stopped refinancing those debts and Portuguese banks had to step in, depriving the rest of the economy of loans needed for it to pull itself out of the worst recession in decades.
The Portuguese 2 year bond yield shot up 10% overnight.
Interestingly, what I have noticed over the last week is the sudden rise in statements from European leaders that they may simply let Greece go:
Angela Merkel has cast doubt for the first time on Europe’s chances of saving Greece from financial meltdown and sovereign default, conceding that Europe’s first ever multibillion bailout coupled with savage austerity was not working after two years of crisis that has brought the single currency to the brink of unravelling.
“We haven’t overcome the crisis yet,” Merkel said. “Of course, there’s Greece, a special case where, despite all the efforts that have been made, neither the Greeks themselves nor the international community have yet managed to stabilise the situation.”
And I see nothing in Angela Merkel’s Davos speech that suggests that is about to change.
Maybe that isn’t a surprise either, as some commentators are suggesting that European leaders never actually intended to give Greece any more money anyway: