euro zone update- markets yet to discount the discounts

The issues I’ve been discussing over the last year or two while now crystallizing, remain highly problematic.

The idea of Greek default transformed from being a Greek punishment to a gift, with the pending question: ‘If Greece doesn’t have to pay, why do I?’- threatening a far more disruptive outcome that is yet to be fully discounted.

That is, should Greek bonds be formally discounted, the consequences of merely the political discussion of that question will be all it takes to trigger a financial crisis rivaling anything yet seen.

And note, also as previously discussed, that there has yet to be an actual Greek default, and that all Greek bonds have continued to mature at par, as there has yet to be an acceptable alternative.

So what are the alternatives?

1. Continue to fund Greece with terms and conditions.
2. Don’t fund Greece which forces:
  a. Greece is forced to limit spending to actual tax revenues
  b. Greece moves back to the drachma

And what are the ‘terms and conditions’?

Austerity is always the lead demand, which slows both the Greek economy and to some extent the euro zone in general.

Additional demands currently include discounting Greek bonds to bring down their debt to GDP ratio to ‘sustainable’ levels. However, after 8 months of negotiations, this has proven highly problematic, probably for reasons yet to be fully disclosed. And, as just discussed, there may be a growing awareness that discounting opens Pandora’s box with the politically attractive question ‘if Greece doesn’t have to pay, why do we?’

So what actually happens?

My best guess, and not with a lot of conviction, is that nothing is concluded before the coming maturity dates, and the ECB winds up writing the check to support short term Greek funding to buy more time for more inconclusive discussion. So, again as previously discussed, seems like this is the solution- death by 1,000 cuts and reluctant ECB bond buying when push comes to shove to keep it all going.

And, currently, the catastrophic risk I’d highly recommend immediately hedging is the risk that Greek bonds are formally discounted, rapidly followed by a global discussion of ‘so why should we have to pay?’ Possible immediate consequences of that discussion include a sharp spike in gold, silver, and other commodities in a flight from currency, falling equity and debt valuations, a banking crisis, and a tightening of ‘financial conditions’ in general from portfolio shifting, even as it’s fundamentally highly deflationary. And while it probably won’t last all that long, it will be long enough to seriously shake things up.

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23 Responses to euro zone update- markets yet to discount the discounts

  1. Gary says:

    The Greek default question is still framed as Greek punishment – at least in public.
    Also, there was so much noise generated on the question of the size of Greek debt (as ratio to GDP) – that politicians will be forced to do something about it. Moreover that the mainstream ideology places so much importance in that ratio. So far they are framing Greek question as unique, and hoping that others will not dare to ask for debt reduction – especially if the Greece will be severely punished.

    Reply

  2. Dimm says:

    @Adam (ak),

    So Bulgaria is 2 years away from Kosovo?

    Reply

    Adam (ak) Reply:

    @Dimm,

    First of all what I wrote was a bit ironic.
    You have made an assumption about the equal pace of decline. What if Bulgaria is not declining at all but the PIIGS countries are merely catching up with the post-communist members of the Bloc?

    I have never been in Bulgaria. The only country I am very familiar with is Poland and I know a few things about Ukraine, Russia etc. Regarding Kosovo I am not defending the criminal acts committed by mad Serb nationalists led by Milosevic but the West may still pay the price for violating the principles of sovereignty and peace order established after WW2. Yugoslavia would not have split without foreign meddling from both sides.

    Reply

  3. Adam (ak) says:

    The impressive achievements of the Eurocracy in Grece:

    “Some signs of improvement in Greek economy
    On January 31, Prime Minister Lucas Papademos presented to his European Union counterparts at the European Council in Brussels this selection of graphs and economic data displaying the progress that the Greek economy has made in some areas since 2009.”

    http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_12464_10/02/2012_427207

    Almost like Khruschev declaring that USSR would overtake the US in technology and GDP.

    5 more years of internal deflation and they overtake Bulgaria in low labour cost. 7 more years and they finally achieve the status similar to Kosovo, the first almost finished masterpiece of EU foreign policy in the region.

    Reply

  4. Adam (ak) says:

    What I’ve heard from somebody still living in Europe is that the main game for Mrs Merkel is to enforce the anointment of Mr Sarkozy for the next term rather than solve the “problems”. Greece is rather low on her priority list as long as does not stink too much. It is still useful as a scarecrow. Can the can be kicked further down the road?

    Reply

  5. Samuel G says:

    Could you please explain what you mean by this, I do not understand. Thanks:

    “a tightening of ‘financial conditions’ in general from portfolio shifting”

    Reply

    WARREN MOSLER Reply:

    harder to get loans

    Reply

  6. SteveK9 says:

    This has probably been discussed at length, but could this have been handled by writing down some Greek debt, ECB buying other PIIGS bonds at low interest, deficit spending to stimulate economies? I realize that does not deal with the imbalances within the EMU.

    Reply

  7. Talvez... says:

    Ah, but there are other ways – forced placement of public debt and abolition of the freedom of capital circulation from Greece.

    Reply

  8. jason m says:

    Unrelated, but I never know where to post if i have general MMT questions. Anyway:

    What influence does QE have (if any) on the price is the US dollar compared to other currencies? If it has influence, how operationally does it occur? Also, does it have any influence on inflation expectations? Finally, is there a ‘wealth effect’ from QE whereby investors are pushed into riskier assets?

    Looked through mandatory readings but can’t see anything directly related.

    help! (I’m blogging against a monetarist on huffpost)
    thanks

    Reply

    Ed Rombach Reply:

    @jason m,

    From what I understand of MMT there is no real effect on the dollar because the net aggregate of US$ financial assets as defined by Treasury holdings plus currency reserves remains unchanged. In other words it is just an exchange of financial assets — Treasuries vs. currency reserves, otherwise known as an asset swap.

    However, perception often becomes reality and many market participants (probably most) equate QUANTITATIVE EASING with the Fed printing money. Therefore they will adjust portfolio holdings accordingly. i.e. sell the dollar, buy risk assets like commodities, equities and credit, and of course sell Treasuries…especially long duration.

    Reply

    Talvez... Reply:

    @jason m,
    Some empirical (UK) data:
    http://www.3spoken.co.uk/2011/10/qe-in-uk-and-value-of-sterling.html

    Reply

  9. Rob says:

    Not that anything is ever cast in stone over there, but hasn’t Merkozy already squashed this, and it was fairly well publicized?

    http://www.ft.com/intl/cms/s/0/d0d39098-1f53-11e1-90aa-00144feabdc0.html#axzz1lzEz2YGw

    Reply

    Joe Reply:

    @Rob,

    Merkel and Sarkozy have to say it. It doesn’t mean it’s true. If Greece is helped in any form, then other countries will also feel that the ECB will come to their rescue, there will be an incentive to take more risk (i.e. spend more). That’s not even taking into account the way citizens will behave. For years the Greeks haven’t paid their taxes and by the ECB lending a hand, they’ll be rewarded for it. Citizens of other nations could stop paying taxes if the benefits outweigh the potential consequences. Unfortunately, as Warren stated, there aren’t many options on the table for Greece.

    Reply

    Hepionkeppi Reply:

    Greece should to fiscal austerity in euro spending, while at the same time do fiscal stimulus in drachma spending.

    It’s all so simple, really! Exit from the eurozone does not have to mean conversion of every monetary unit in the area to some other monetary unit.

    Reply

  10. Hepionkeppi says:

    Warren,

    did you participate in the contest for the best euro brak-up plan?

    Im talkin about this: http://www.bbc.co.uk/news/business-15366828

    Reply

    WARREN MOSLER Reply:

    yes, sent an entry, but fell short of the ‘required’ 15,000 words.

    Reply

    roger erickson Reply:

    @WARREN MOSLER,

    That’s the funniest thing I’ve heard all year! Should go right up there with Hemingway’s shortest shortsell story.

    The only thing better than gallows humor is cryptic humor.

    Reply

  11. Monica Smith says:

    Souls are to be saved. Money is to be spent. Get used to it. Why should I pay back what I promised? ‘Cause that’s what’s honest. If people can’t be trusted, they need to be shunned.

    Reply

    Art Patten Reply:

    @Monica Smith,

    “Souls are to be saved.”

    They can only be saved if God has first ‘spent’ them into existence.

    And money owed can only be repaid when the supply of unencumbered financial assets is sufficient, which is not the case in the EMU today.

    Did half the American electorate support bimetallism in the 1890s simply because they were all deadbeats? Probably not.

    Reply

    pebird Reply:

    @Art Patten, In the long run we are all deadbeats.

    Reply

    roger erickson Reply:

    @pebird,

    She should read “The Economic Consequences of the Sugar Beets.”

    Art Patten Reply:

    @pebird,

    :)

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