Friday, April 30, 2010

Greece: Setting Up for the Final Act?

According to our esteemed financial press it is almost a done deal. Greece has agreed to austerity measures designed to cut their deficit by 10% of GDP in three years and with this they will get an infinite amount of money from the IMF (20% courtesy of American taxpayers). With this financing, they will not have to come to market anymore (why are 2 year bonds still trading over 12%?).

"There was not much room for us to negotiate," the Greek official said. "This is the way the IMF works—if you want the money, you go by their terms. "
Makes sense. In the old days, before too big to fail, lenders used to dictate covenants for emergency financing. The IMF, as we know, thinks all the Greeks have to do is cut spending and raise taxes. Apparently, the Greeks needed the IMF to show them they didn't need to run deficits all those years because their economy would have worked the same with much less spending.

Interestingly enough, this flies in the face of the Trillions in stimuli that have been showered in the US, China, Brazil, the UK, and others, based on the theory that the worst thing you can do to a slumping economy is cut spending. I suppose Keynesianism only works in countries of certain size? I guess I missed that lecture in my macro 101.

In any case, it is clear that the overpaid geniuses at the IMF are back to their old methods. The debt must be paid at all costs because it was issued. Whether there is any chance of the Greek economy ever generating enough surpluses to pay the IMF, now first in line ahead of the bondholders, it is apparently of no interest to the politicians who just want this unforeseen crisis to away fast.

Meanwhile, in Athens, the unions are certainly going to think about what it is best for them. Can you blame them? At some point, they may realize that the problem is as much Germany's (or France's) as much as it is theirs. Why? because if Greece cannot deliver the austerity measures and the IMF does not provide the money to cover the deficit the German banks will lose (again) several billion euros. In this context, it is perfectly reasonable for the Greeks to claim shared responsibility and reject the austerity terms while accepting the money. At that point, the Greek politicians will prefer the voters to their friends in high places.

Therefore, if you think this crisis is over I suggest you consider you consider what would you do if they cut your salary because the government has issued too much debt. If you think this is a ridiculous proposition because Greek public employees are, in your view, overpaid, consider how much success you think you could have convincing them (hint: Greek unions do not like to be pushed around).

The bottom line is that, no matter what the Greek government says, a 10% deficit cut will be difficult to implement. The guys at the IMF have plenty of experience in the matter. If I have to bet, I'd guess the first audit will result in a disagreement of some kind over lack of progress. At that time, the IMF, after consultation with the G7, will issue a waiver. By then, the markets may be ready to reconsider the viability of the Greek debt (by then) junior to the IMF loans

Of course, it is possible that this time will be different and Greece will be the first country ever to emerge from a situation like this without a devaluation.

Meanwhile, the Greek bond curve is still inverted.

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