Showing posts with label Greece. Show all posts
Showing posts with label Greece. Show all posts
August 20, 2016
August 19, 2016
April 10, 2016
May 25, 2013
Cosmetic surgery boom in crisis-stricken Greece and Italy
While the Greek economy remains under the proverbial knife of the
Troika, it appears the wealthy are unconcerned by the plight of their fellow countrymen.
Der Spiegel reports that not only does Greece have the second highest rate of cosmetic surgery per capita in the world but thanks to a slumping economy, surgeons have cut prices by up to 40% while rich Greeks are never as before rushing to improve their looks.
Via Der Spiegel,
The economic crisis has forced thousands in Greece to rely on volunteers for even basic health care services.
Meanwhile, wealthier Greeks are having more facelifts and breast implants than anywhere in the world.
...
Every year, the International Society of Aesthetic Plastic Surgery (ISAPS) performs a survey of the number of plastic surgery procedures performed worldwide. When the numbers are compared to a country's population, the results are surprising for Greece. In 2011, 142,394 procedures were performed in the country, with its population of about 11 million. That means that, on average, one in 79 Greeks has had procedures such as liposuction, eyelid corrections and Botox injections performed on them. Worldwide, the Greeks rank only second to the South Koreans in terms of the number of cosmetic procedures performed per 1,000 inhabitants (see graphic). In Germany, with a population of about 81 million, there were 415,448 procedures in 2011, or one in about 200.
2011 was the year of the economic crisis, and yet Greece rose even higher in the international ranking. Looking good still seems to be important to the Greeks.
April 13, 2013
Household Wealth in Europe
The ECB has finally published the all-country report which gives us an indication of where household wealth is located and where in the future bailouts private wealth will be confiscated. The data is from 2009-2010 so especially in the PIIGS countries it could be overinflated after 3 years of austerity still is a powerful indicator of major unbalances in the Eurozone.
Italian median household wealth was indeed over three times larger than Germany’s. But that wasn’t the problem. The problem was Cyprus.
Cypriot
households (CY), as measured by both their median and average wealth,
were the second richest in the Eurozone. Median household wealth of €266,900 was over five times Germany’s median of €51,400.
Average household wealth reached a phenomenal €670,900, 3.4 times
Germany’s €195,200, and just shy of Luxembourg’s €710,100. Rarefied
levels of wealth achievable only by small countries with huge and murky
banking centres, or lots of oil. Few countries in the world are in that
elite club.
And Germans based on median household wealth, were the poorest in the Eurozone.
It wasn’t that Cypriot households earned a lot of money—they earned the same as German households! They just knew how to hang on to it. At least until their bubble blew up.
By now, wealthier German
households, those who own property and stocks, are significantly better
off than they were in 2010, and they have since pulled up the average.
Median household wealth, however—almost none of them own property or
stocks—has certainly been left behind, again.
In the meanwhile in Cyprus real estate values, after a mind-boggling bubble, have
been plunging for over two years; and billions in bank deposits have
evaporated.
Spanish household wealth has also been caught in a
downward spiral of devastating unemployment and an exploding housing
bubble—Spanish households lead the survey with a homeownership rate of
83%. In 2010, homeowners valued their homes at bubble prices. By now, much of the home equity Spaniards were
clinging to has dissipated—with dramatic impact on
household wealth.
Central bank sources
told the FAZ that the Bundesbank and the ECB, to avoid stirring up a
storm at an inconvenient time, kept this explosive wealth data secret
until after the Cyprus bailout had been decided. But the data also
explains the political motivation for the haircuts of account holders in
Cypriot banks.
April 9, 2013
Europe Stagflation risks
Hard times ahead for Cyprus and the PIGS.
Bloomberg has ranked countries based on their risk of stagflation.
Stagflation, a combination of stagnation and inflation, is a term used in economics to describe a situation where inflation is high while the economic growth rate slows down, and unemployment remains steadily high.
It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa.
The lower the score, the greater the risk of stagflation.
Cyprus was found to be most at risk of stagflation with a Stagflation Score of -4.733, followed by Portugal (-2.671), Italy (-2.133), Spain(-1.745) and Greece (-1.366). Switzerland was ranked least at risk with a score of (7.560), followed by China (2.612) and Japan (2.446).
Bloomberg has ranked countries based on their risk of stagflation.
Stagflation, a combination of stagnation and inflation, is a term used in economics to describe a situation where inflation is high while the economic growth rate slows down, and unemployment remains steadily high.
It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa.
The lower the score, the greater the risk of stagflation.
Cyprus was found to be most at risk of stagflation with a Stagflation Score of -4.733, followed by Portugal (-2.671), Italy (-2.133), Spain(-1.745) and Greece (-1.366). Switzerland was ranked least at risk with a score of (7.560), followed by China (2.612) and Japan (2.446).
Source: Bloomberg Brief
March 2, 2013
Poverty in Europe
Italy is now worse than Spain, its poverty rate has climbed to 28.2%, even though the unemployment rates in the two nations are vastly different (Spain 26% and Italy 11.2%) reasons for such a higher poverty rate despite lower unemployment rates range from higher corruption levels compared to Spain to lack of unemployment benefits in Italy. Hardly surprising then that people voted en masse for Grillo and his MS5 which supports creating a dole system for those unable to find a job.
November 14, 2012
September 25, 2012
One third of Athens' Businesses Shuttered
Greek unemployment surged by 1% in one month to 24.4%, and by the end of the year is likely to be nearly 30%. What this means in practical tax revenue terms (if the tax collectors were actually doing their job collecting taxes, instead of striking) is that there is nobody generating any economic products and services, and thus no state revenues.
Kathimerini confirmed in a report that almost a third of all business in Athens have now shuttered: "The number of shuttered shops on the capital's busiest commercial streets, Panepistimiou and Stadiou, also hit a record high in August, reaching 34.7 percent on Panepistimiou and 42 percent on Akadimias, up 14 percent in the last six months."
More:
Greece's deep recession has forced almost a third of businesses in the capital's commercial district to close down as shrinking incomes and frequent strikes drive Athenians away.
Tens of thousands of small businesses, which make up a big chunk of the struggling economy, have shut since Greece secured a 110-billion-euro bailout package in 2010 in exchange for promises of painful austerity measures.
On the capital's cobbled pedestrian shopping streets, long lines of shops are boarded shut while others have «Everything must go» signs plastered across their windows. Some arcades, once bustling with activity, are empty and enclosed by derelict buildings.
In the city's «commercial triangle», where generations of merchants had run successful businesses a stone's throw from the central Syntagma Square, an August census by retail lobby group ESEE found 31 percent of shops had closed.
"There are no signs that this percentage will fall and this is very worrying,» said ESEE head Vassilis Korkidis, estimating that about 63,000 Greek businesses were at risk of closing down within the next year.
Economic Freedom of the World
The Fraser Institute's massive volume on the Economic Freedom Of The World - based on the following five factors: Size of Government, Legal System & Property Rights, Sound Money, Freedom to Trade Internationally, and Regulation - covers 42 variables with the goal of quantifying the key ingredients of economic freedom.
When it comes to Europe, Italy manages to leave behind Greece by 2 positions achieving a very dishonourable 83rd position, Spain and Ireland respectively 34th and 12th stays among the most free economies in the world, Portugal is still green in the 60th while Greece at 81 still manage to fare better than Italy.
For those interested to find out what is making Italy so appalling please check the full data below.
September 15, 2012
Competitiveness in the Eurozone
Deutsche Bank in his report on competitiveness
noted the following:
"investors invest in companies and the countries are the platform of the companies. Therefore, an understanding of global competiveness of countries is key for investors"
It is most helpful to look at the combination of competiveness and hourly wages.
The more competitive a country is, the higher its wages can be justified.
There is a clear relation between the two variables. Countries below the regression curve have a strong competiveness rank relative to their labour costs while countries above the curve have a lower competiveness rank relative to their labour costs.
and here why PIIGS are screwing up:
"investors invest in companies and the countries are the platform of the companies. Therefore, an understanding of global competiveness of countries is key for investors"
It is most helpful to look at the combination of competiveness and hourly wages.
The more competitive a country is, the higher its wages can be justified.
There is a clear relation between the two variables. Countries below the regression curve have a strong competiveness rank relative to their labour costs while countries above the curve have a lower competiveness rank relative to their labour costs.
and here why PIIGS are screwing up:
August 7, 2012
The Great European Divide
If the recent quarrel between Italy and Germany is a clear signal that political divisions are growing in the dysfunctional Euro family, the graphs below from Goldman Sachs clearly illustrate how the economic divide is already there and widening by the day.
I have highlighted some parts of the report which sound an alarm bell for the month to come.
Goldman Sachs: Focus: Europe’s ‘red line’: Segmentation of the Euro interbank market is significant
Bottom line: A ‘red line’ has descended across Europe, running along the Pyrenees and the Alps. Banks south of this line have difficulty accessing Euro interbank markets, whereas banks north of that line remain better integrated and retain market access. As Mr. Draghi emphasised at last week’s ECB press conference, this segmentation is interfering with monetary policy transmission and thus affecting macroeconomic outcomes. Monitoring the intensity and geographical location of the ‘red line’ will remain crucial going forward, not least to assess the effectiveness of the policy measures announced by the ECB last week.
The charts are presented in the form of heat maps: ‘hot’ colours (red) reflect a high degree of financial interaction, whereas ‘cold’ colours (blue) point to financial isolation.
In 2008 Q1 before the failure of Lehman, integration of Euro interbank markets was high: i.e. Chart 1 is predominantly red. With the notable exception of Greece, banks in all Euro area countries have significant claims on all other Euro area countries. Ireland, Spain and Italy are all well-embedded into the Euro interbank markets.
In 2012 Q1 as the European sovereign crisis has intensified, integration has broken down: i.e. Chart 2 is predominantly blue. In particular, the three programme countries (Greece, Portugal and Ireland) have become isolated. Spain (and to a lesser extent Italy) are also drifting towards greater isolation, whereas among Germany, France and the Netherlands integration remains significant, albeit still diminishing.
A ‘red line’ has emerged in Euro interbank markets – and is shifting northwards. To draw on the credit rationing literature in economics, banks in the periphery have been “red-lined”, i.e. simply on account of their residency, they are being excluded from the Euro interbank markets.
This red line has long isolated the program countries. And it is now moving northwards: Italy and (especially) Spain are vulnerable. A ‘red line’ running along the Pyrenees and Alps cleaves the big-4 countries at the heart of the Euro area in two. Given the deep recessions being suffered in Spain and Italy, the implications for borrowers and the real economy – as well as for the ability of monetary policy to ease tight financing conditions – are self-evident.
Source: Goldman Sachs
I have highlighted some parts of the report which sound an alarm bell for the month to come.
Goldman Sachs: Focus: Europe’s ‘red line’: Segmentation of the Euro interbank market is significant
Bottom line: A ‘red line’ has descended across Europe, running along the Pyrenees and the Alps. Banks south of this line have difficulty accessing Euro interbank markets, whereas banks north of that line remain better integrated and retain market access. As Mr. Draghi emphasised at last week’s ECB press conference, this segmentation is interfering with monetary policy transmission and thus affecting macroeconomic outcomes. Monitoring the intensity and geographical location of the ‘red line’ will remain crucial going forward, not least to assess the effectiveness of the policy measures announced by the ECB last week.
From hot to cold: The periphery is being frozen out. Charts 1 and 2 show the row country’s bank claims on the column country’s banks, in 2008 Q1 and 2012 Q1 respectively. The numbers capture these claims expressed as a percentage of the column country’s (quarterly) GDP in 2008 Q1. Of course, representing the data in this form is not a neutral choice. But the basic insights revealed are not sensitive to our choice of scaling variable.“… financial fragmentation hinders the effective working of monetary policy”. Mr. Draghi’s comments at last week’s ECB press conference have placed the segmentation of Euro financial markets at centre stage. In this daily, we explore the nature of that fragmentation, focusing on the Euro interbank markets.
The charts are presented in the form of heat maps: ‘hot’ colours (red) reflect a high degree of financial interaction, whereas ‘cold’ colours (blue) point to financial isolation.
In 2008 Q1 before the failure of Lehman, integration of Euro interbank markets was high: i.e. Chart 1 is predominantly red. With the notable exception of Greece, banks in all Euro area countries have significant claims on all other Euro area countries. Ireland, Spain and Italy are all well-embedded into the Euro interbank markets.
In 2012 Q1 as the European sovereign crisis has intensified, integration has broken down: i.e. Chart 2 is predominantly blue. In particular, the three programme countries (Greece, Portugal and Ireland) have become isolated. Spain (and to a lesser extent Italy) are also drifting towards greater isolation, whereas among Germany, France and the Netherlands integration remains significant, albeit still diminishing.
A ‘red line’ has emerged in Euro interbank markets – and is shifting northwards. To draw on the credit rationing literature in economics, banks in the periphery have been “red-lined”, i.e. simply on account of their residency, they are being excluded from the Euro interbank markets.
This red line has long isolated the program countries. And it is now moving northwards: Italy and (especially) Spain are vulnerable. A ‘red line’ running along the Pyrenees and Alps cleaves the big-4 countries at the heart of the Euro area in two. Given the deep recessions being suffered in Spain and Italy, the implications for borrowers and the real economy – as well as for the ability of monetary policy to ease tight financing conditions – are self-evident.
Source: Goldman Sachs
August 4, 2012
September will be Crunch Time for Europe
"September will undoubtedly be the crunch time," one senior euro zone policymaker said. "In nearly 20 years of dealing with EU issues, I've never known a state of affairs like we are in now," one euro zone diplomat said this week. "It really is a very, very difficult fix and it's far from certain that we'll be able to find the right way out of it."
As eurocrats take their mandatory vacations for a job well done, Europe will enter hibernation mode, until September which according to Reuters "is shaping up as a "make-or-break" month as policymakers run desperately short of options to save the common currency."
Reuters explains why September will also be known as the popcorn month:
In Reuters' own words, the life raft is about to go pop:In that month a German court makes a ruling that could neuter the new euro zone rescue fund, the anti-bailout Dutch vote in elections just as Greece tries to renegotiate its financial lifeline, and decisions need to be made on whether taxpayers suffer huge losses on state loans to Athens.
On top of that, the euro zone has to figure out how to help its next wobbling dominoes, Spain and Italy - or what do if one or both were to topple.
Since the crisis erupted in January 2010, the euro zone has had to rescue relative minnows in Greece, Ireland and Portugal as they lost the ability to fund their budget deficits and debt obligations by borrowing commercially at affordable rates.
Now two much larger economies are in the firing line and policymakers must consider ever more radical solutions.
The euro zone does not seem to have enough cash in the current setup to deal with a scenario of Spain and Italy needing a rescue, and a sense of doom is growing among some policymakers. Fighting the crisis, said the euro zone diplomat, is like trying to keep a life raft above water.
"For two years we've been pumping up the life raft, taking decisions that fill it with just enough air to keep it afloat even though it has a leak," the diplomat said. "But now the leak has got so big that we can't pump air into the raft quickly enough to keep it afloat."
Compounding the problems, Greece is far behind with reforms to improve its finances and economy so it may need more time, more money and a debt reduction from euro zone governments.
But Greece is, once again, just the beginning.
All this, and much more, is finally coming to a head, as the time for can kicking is running out.Sept. 12 is a crucial date in the European diary. On that day the German Constitutional Court is scheduled to rule on whether a treaty establishing the euro zone's permanent bailout fund, the 500 billion euro European Stability Mechanism (ESM), is compatible with the German constitution.
A positive ruling is vital, because Germany is the biggest funder of the ESM, and the euro zone would be powerless to protect Spain or Italy without the ESM.
On the same day, parliamentary elections are held in the Netherlands where popular opposition to spending any more money on bailing out spendthrift euro zone governments is strong. The Dutch vote may complicate talks on a revised second bailout for Greece, which also has to be agreed in September.
A full timeline of the incoming events, courtesy of Deutsche Bank is listed below:
August:
- 13 August: Italy auction. Bills
- 14 August: Italy auction. Bonds
- 14 August: Euro area Q2 GDP flash estimate, from Eurostat.
- Mid-August: French Constitutional Court/Fiscal Compact. In Mid-August the French Constitutional Court is due to rule whether the Fiscal Compact, which euro area countries are due to endorse by the start of 2013, needs to be ratified into the French Constitution. If so, a joint vote by the French Assembly would be required. Signals are that this would happen in September if required. See accompanying article on France in this issue of Focus Europe.
- 16 August: Spain auction. Bonds
- 20 August: Greek bond redemption. Greece is due to repay EUR3.1bn of GGBs. Following the PSI, these would be GGBs owned by the ECB and EIB. While agreement on how to reconfigure the second loan programme is unlikely before September, it is unlikely the EU will hold-out from paying funds to Greece to repay the ECB/EIB. In a consolidated sense, the official sector’s exposure to Greece remains the same, but the creditor changes (to the EFSF). Alternatively, Greece could issue T-bills and the Greek banks could absorb them with the assistance of ELA from the Greek central bank.
- 21 August: Spain auction. Bills
- 28 August: Spain auction. Bills
- 28 August: Italy auction. Bonds
- 29 August: Italy auction. Bills
- 30 August: Italy auction. Bonds
- End-August: DBRS rating on Spain/Ireland. By the end of August, the DBRS ratings agency is due to have concluded its review of Spanish and Irish sovereign ratings.
- September: Moody’s due to conclude review of Spanish sovereign rating. Logically Moody's should wait until there is clarity on direct recap before making a decision on Spain’s rating. Since governments have not made progress fleshing out a direct recapitalisation facility — indeed, have created some ambiguity as to whether it will be non-recourse — there is a distinct risk that Moody's, in another move to be “ahead of the curve”, decides to downgrade Spain within the next 3 months. Moody’s currently rates Spain Baa3, the lowest investment grade rating.
- September: Detailed bottom-up Spanish bank stress tests due for publication.
- 6 September: Spain auction. Bonds
- 6 September: ECB Governing Council meeting. If we are right about the outcome of the 2 August ECB meeting (dominated by “quantity” measures), we suspect that revisions to staff forecasts for growth and inflation are likely to be a basis for a 25bp rate cut.
- 11 September: Greece auction. Bills
- 12 September: German Constitutional Court ESM ruling. The German Constitutional Court is to rule on the complaints lodged against the ESM and fiscal compact. The chances of the ESM being vetoed are low. However, the Court might again strengthen the German Parliament’s prerogatives as regards future European integration (see Focus Germany, 20 July). Germany is the last approval needed for the ESM to come into effect. Then the first instalment of the capital has to be paid by the ESM members within 15 days of the ESM treaty entering into force. There are three other countries where Constitutional Court queries are outstanding — France, Austria and Ireland. France’s Constitutional Court will be deciding by mid-August. Neither Austria (which may take another 3-6 months) nor Ireland are large enough to hold back the ESM — the ESM will come into force when countries representing 90% of the subscribed capital have approved it. Both Germany and France have an effective veto power in that case.
- 12 September: Dutch Election. In April, the VVD/CDA minority government failed when Geert Wilders' PVV party withdrew its support amid negotiations for the 2013 austerity budget. A crisis was averted when three smaller parties came forward to give support to a budget, but an early election was unavoidable. Domestic austerity and European crisis issues will likely play important roles in the election. Compared to the configuration of parliament at the October 2010 election, the latest opinion polls (Maurice de Hond) show PM Rutte's VVD liberal party vying with the Socialist Party for the dominant party position. Both would gain 31 seats in the 150 seat parliament on the latest polls. This is an unchanged position for VVD, but a doubling of SP seats. SP are gaining at the expense of all other parties except VVD and neo-liberal D66. This may reflect a backlash against the austerity for 2013 which has broad party political support. SP have also taken a stance against euro rescue initiatives, voting against the ESM alongside the PVV and extracting a pledge from Dutch FinMin De Jager that parliament will vote on any future direct bank recapitalisation disbursements. Given the typical distribution of the vote among several parties, the questions are what coalition emerges from this election, how long it takes to form a government and what policies will it support? Markets in particular will be watching the ramifications for domestic fiscal policy (the 2013 Budget is a week after the election) and euro rescue initiatives.
- 12 September: Italy auction. Bills
- 13-14 September: G20 Finance Ministers and Central Bankers meeting. In Mexico.
- 13 September: Italy auction. Bonds
- 14 September: ECOFIN meeting. This is very likely the finance ministers meeting when adjustments to Greece's second loan programme will be considered. The remaining EUR23bn recapitalisation of the Greek banks is due to complete by the end of September, assuming a positive review of the loan programme. This is also when finance ministers should have their first discussion on the proposals for a common bank supervisory regime under the ECB. Any delays, with knock-on delays for a direct bank recapitalisation mechanism, will disappoint the market. Options for a reconsideration of Ireland’s legacy bank bailout policies may also be discussed (decision not due until October ECOFIN meeting).
- 15 September: Eurogroup meeting. Coinciding
- 18 September: Greece auction. Bills
- 18 September: Spain auction. Bills
- 20 September: Spain auction. Bonds
- 25 September: Spain auction. Bills
- 25 September: Italy auction. Bonds
- 26 September: Italy auction. Bills
- 27 September: Italy auction. Bonds
Eurozone Game Theory Analysis: Italy expected to exit first
Game Theory is a useful tool for analysing Europe's crisis. Bank of America dedicated a full report to a game theory scenario on the Euro Breakup, analysing the costs and benefits of a voluntary exit from the Euro-area for the core and periphery countries. The results are shocking.
Italy and Ireland (not Greece) are expected to exit first (with Italy having a decent chance of an orderly exit) and while Germany is the most likely to achieve an orderly exit, it has the lowest incentive to exit the euro-zone - since growth, borrowing costs, and a weakening balance sheet would cause more pain.
Ultimately, they play the game out and find out that while Germany could 'bribe' Italy to stay, they will not accept and Italy will optimally exit first - suggesting a very dark future ahead for the Eurozone.
The cost of insuring against EUR tail risk, which was already in retreat even before the EU Summit, has fallen further since, is at 2 year lows.
One of the most provocative observations of modern game theory is that the most likely outcome is not always the optimal one. Put differently, the dominant strategy for game players is not always to cooperate, even when everyone is better off if they do.
The most famous illustration of this is the Prisoner’s Dilemma. In this game, two men are arrested. The police offer both men a similar deal. If one testifies against the other, and the other stays silent, the betrayer goes free while the one who remains silent gets a one-year sentence. If both remain silent, they will each get a one-month sentence. If both decide to testify against the other, each will get a three-month sentence. Even though both will be better off if they stay silent, the “Nash equilibrium” is that both men will testify against each other. This is because from the perspective of each prisoner, regardless of what the other person does, he can be better off by betraying.
The prisoner’s dilemma problem can help us better understand the dynamics of the eurozone crisis.
Below (Table 1), we present a highly abstract, stylized form of the game that Germany and Greece have been playing for the last two years. Greece is given two options: austerity or no austerity. Germany also has two options: Eurobonds or no Eurobonds. For each of the four possible outcomes a certain payoff is assigned for each country that is meant to be illustrative, but captures the essence of the different political/economic considerations of the two countries.
As the payoffs in Table 1 imply, both countries would fare better if they choose to cooperate (Greece agreeing to austerity while Germany agreeing to Eurobonds) than if they do not cooperate (no austerity and no Eurobonds). However, Greece would be even better off if it chooses no austerity but Germany agrees to Eurobonds. Similarly, the best outcome for Germany is that it opts for no Eurobonds but Greece chooses austerity. We assume that neither country knows what the other country is going to do before it has to decide on a course of action.
It is easy to see that the Nash equilibrium is no austerity and no Eurobonds (uncooperative equilibrium). This is because from the point of view of Greece, regardless of what Germany chooses, it will be better off if it opts for no austerity. Similarly, from the point of view of Germany, regardless of what Greece does, it will be better off if it chooses no Eurobonds. As with the Prisoner’s Dilemma, no austerity and no Eurobonds can be shown to be the Nash equilibrium even if we were to allow for the game to be played repeatedly.
The fact that the dominant strategy for both countries is not to cooperate is why now more than two years into the crisis Greece is not closer to implementing a credible reform program and Germany is not any closer to agreeing to Eurobonds.
The obstacle is that neither side is able to make a credible pre-commitment to doing the “right thing,” to the extent that there is no enforcement mechanism to ensure that each country lives up to its promises.
The lack of an enforcement mechanism is why the Germans are demanding that fiscal union will have to precede Eurobonds. Fiscal union, by taking fiscal policy out of the hands of the national governments, solves the pre-commitment problem. However, very few eurozone countries are willing to entertain the notion of giving up their independent fiscal policy, especially given that, as members of the monetary union, they do not have recourse to an independent monetary policy.
If the eurozone is no closer to a fiscal union and Eurobonds, we need to consider other potential outcomes of the crisis. Much has been said about involuntary exit from the eurozone , but what about the chances of a voluntary exit, meaning a country (or multiple countries) opting to call it quits on its (their) own accord?
Voluntary Exit?
A decision to stay or exit should be dictated by a cost and benefit analysis. What are some of the considerations that should go into such an analysis? There are four key questions that will have to be answered before any such decision can be made:
What are the chances for an orderly exit?
What is the impact on growth following an exit?
What is the impact on borrowing costs following an exit?
What is the impact on the country’s balance sheet following an exit?
Two very interesting results emerge:
Even though much of the market focus on exit risk has been on Greece, Italy and Ireland have the highest relative incentive to voluntarily exit the euro, by our analysis. In the case of Italy, it faces a relatively higher chance of achieving an orderly exit and it stands to benefit significantly from competitive gains, growth gains and even balance sheet gains. No wonder former Prime Minister Berlusconi has been recently quoted as saying that leaving the euro is not a “blasphemy.” Among the peripheral countries, Spain appears to have the lowest relative incentive to leave.
While Germany is the country most likely to achieve an orderly exit from the Euro, it also has the lowest incentive of any country to leave. It would suffer from lower growth, possibly higher borrowing costs, and negative balance sheet effect. Austria, Finland and Belgium don’t have strong incentive to leave, either.
Can Germany “bribe” Italy to stay?
Incentive to leave the euro varies from country to country. Among the major economies, Italy stands the most to gain from exiting, whereas Germany has the most to lose from exiting. Germany would also lose from the exit of other countries. (Say Italy leaves the euro but Germany stays. German holdings of Italian liabilities would fall in value, German exports to Italy would suffer and German companies would now face more competitive Italian manufacturing firms.) Does this mean that Germany would be willing to pay a price for Italy (as it has for Greece, Ireland, and Portugal) to stay in the euro? The answer is Yes but would Italy accept it.
What is the Nash equilibrium of this game?
Italy is clearly better off exiting than staying (after Germany has already paid the “bribe”), as the payoff for Italy in outcome 4 is inferior to the payoff in outcome 3. If we can see this, so can Germany in period 2. Whether it pays or not, Italy will exit in the following period. Therefore, Germany is better off by not paying. Now in period 1, Italy can make the informed calculation that Germany will not pay. This means that Italy has an incentive to exit in period 1. The bottom line is that the only stable equilibrium of this game is that Italy exits the euro and, more importantly, it exits already in period 1.
This game and the analysis in the previous section would suggest that we should not expect what has already happened between Germany and Greece during the eurozone crisis to play out the same way for Italy if the crisis spreads. Italy has more incentives than Greece to voluntarily exit the eurozone, in our view, while it will be more expensive for Germany to keep Italy in the eurozone. This means that Italy could be even more reluctant than Greece to accept tough conditionalities for staying.
Only a weak Euro can save the Eurozone
Despite the depreciation of the euro in the last three years, it is still nearly 10% stronger than where it was in 2000. Against the USD, it is still 45% stronger than its low in November 2000.
A much weaker Euro would significantly reduce the incentive of any country to exit. For example, a 20% depreciation of the EUR against the USD would reduce by nearly half the loss of competitiveness of Italy to the US since the inception of the Euro.
Italy and Ireland (not Greece) are expected to exit first (with Italy having a decent chance of an orderly exit) and while Germany is the most likely to achieve an orderly exit, it has the lowest incentive to exit the euro-zone - since growth, borrowing costs, and a weakening balance sheet would cause more pain.
Ultimately, they play the game out and find out that while Germany could 'bribe' Italy to stay, they will not accept and Italy will optimally exit first - suggesting a very dark future ahead for the Eurozone.
The cost of insuring against EUR tail risk, which was already in retreat even before the EU Summit, has fallen further since, is at 2 year lows.
One of the most provocative observations of modern game theory is that the most likely outcome is not always the optimal one. Put differently, the dominant strategy for game players is not always to cooperate, even when everyone is better off if they do.
The most famous illustration of this is the Prisoner’s Dilemma. In this game, two men are arrested. The police offer both men a similar deal. If one testifies against the other, and the other stays silent, the betrayer goes free while the one who remains silent gets a one-year sentence. If both remain silent, they will each get a one-month sentence. If both decide to testify against the other, each will get a three-month sentence. Even though both will be better off if they stay silent, the “Nash equilibrium” is that both men will testify against each other. This is because from the perspective of each prisoner, regardless of what the other person does, he can be better off by betraying.
The prisoner’s dilemma problem can help us better understand the dynamics of the eurozone crisis.
Below (Table 1), we present a highly abstract, stylized form of the game that Germany and Greece have been playing for the last two years. Greece is given two options: austerity or no austerity. Germany also has two options: Eurobonds or no Eurobonds. For each of the four possible outcomes a certain payoff is assigned for each country that is meant to be illustrative, but captures the essence of the different political/economic considerations of the two countries.
As the payoffs in Table 1 imply, both countries would fare better if they choose to cooperate (Greece agreeing to austerity while Germany agreeing to Eurobonds) than if they do not cooperate (no austerity and no Eurobonds). However, Greece would be even better off if it chooses no austerity but Germany agrees to Eurobonds. Similarly, the best outcome for Germany is that it opts for no Eurobonds but Greece chooses austerity. We assume that neither country knows what the other country is going to do before it has to decide on a course of action.
It is easy to see that the Nash equilibrium is no austerity and no Eurobonds (uncooperative equilibrium). This is because from the point of view of Greece, regardless of what Germany chooses, it will be better off if it opts for no austerity. Similarly, from the point of view of Germany, regardless of what Greece does, it will be better off if it chooses no Eurobonds. As with the Prisoner’s Dilemma, no austerity and no Eurobonds can be shown to be the Nash equilibrium even if we were to allow for the game to be played repeatedly.
The fact that the dominant strategy for both countries is not to cooperate is why now more than two years into the crisis Greece is not closer to implementing a credible reform program and Germany is not any closer to agreeing to Eurobonds.
The obstacle is that neither side is able to make a credible pre-commitment to doing the “right thing,” to the extent that there is no enforcement mechanism to ensure that each country lives up to its promises.
The lack of an enforcement mechanism is why the Germans are demanding that fiscal union will have to precede Eurobonds. Fiscal union, by taking fiscal policy out of the hands of the national governments, solves the pre-commitment problem. However, very few eurozone countries are willing to entertain the notion of giving up their independent fiscal policy, especially given that, as members of the monetary union, they do not have recourse to an independent monetary policy.
If the eurozone is no closer to a fiscal union and Eurobonds, we need to consider other potential outcomes of the crisis. Much has been said about involuntary exit from the eurozone , but what about the chances of a voluntary exit, meaning a country (or multiple countries) opting to call it quits on its (their) own accord?
Voluntary Exit?
A decision to stay or exit should be dictated by a cost and benefit analysis. What are some of the considerations that should go into such an analysis? There are four key questions that will have to be answered before any such decision can be made:
What are the chances for an orderly exit?
What is the impact on growth following an exit?
What is the impact on borrowing costs following an exit?
What is the impact on the country’s balance sheet following an exit?
Two very interesting results emerge:
Even though much of the market focus on exit risk has been on Greece, Italy and Ireland have the highest relative incentive to voluntarily exit the euro, by our analysis. In the case of Italy, it faces a relatively higher chance of achieving an orderly exit and it stands to benefit significantly from competitive gains, growth gains and even balance sheet gains. No wonder former Prime Minister Berlusconi has been recently quoted as saying that leaving the euro is not a “blasphemy.” Among the peripheral countries, Spain appears to have the lowest relative incentive to leave.
While Germany is the country most likely to achieve an orderly exit from the Euro, it also has the lowest incentive of any country to leave. It would suffer from lower growth, possibly higher borrowing costs, and negative balance sheet effect. Austria, Finland and Belgium don’t have strong incentive to leave, either.
Can Germany “bribe” Italy to stay?
Incentive to leave the euro varies from country to country. Among the major economies, Italy stands the most to gain from exiting, whereas Germany has the most to lose from exiting. Germany would also lose from the exit of other countries. (Say Italy leaves the euro but Germany stays. German holdings of Italian liabilities would fall in value, German exports to Italy would suffer and German companies would now face more competitive Italian manufacturing firms.) Does this mean that Germany would be willing to pay a price for Italy (as it has for Greece, Ireland, and Portugal) to stay in the euro? The answer is Yes but would Italy accept it.
What is the Nash equilibrium of this game?
Italy is clearly better off exiting than staying (after Germany has already paid the “bribe”), as the payoff for Italy in outcome 4 is inferior to the payoff in outcome 3. If we can see this, so can Germany in period 2. Whether it pays or not, Italy will exit in the following period. Therefore, Germany is better off by not paying. Now in period 1, Italy can make the informed calculation that Germany will not pay. This means that Italy has an incentive to exit in period 1. The bottom line is that the only stable equilibrium of this game is that Italy exits the euro and, more importantly, it exits already in period 1.
This game and the analysis in the previous section would suggest that we should not expect what has already happened between Germany and Greece during the eurozone crisis to play out the same way for Italy if the crisis spreads. Italy has more incentives than Greece to voluntarily exit the eurozone, in our view, while it will be more expensive for Germany to keep Italy in the eurozone. This means that Italy could be even more reluctant than Greece to accept tough conditionalities for staying.
Only a weak Euro can save the Eurozone
Despite the depreciation of the euro in the last three years, it is still nearly 10% stronger than where it was in 2000. Against the USD, it is still 45% stronger than its low in November 2000.
A much weaker Euro would significantly reduce the incentive of any country to exit. For example, a 20% depreciation of the EUR against the USD would reduce by nearly half the loss of competitiveness of Italy to the US since the inception of the Euro.
June 13, 2012
Greek Bank Run hits new record, $1 Billion in 24 hours
Reuters now
estimates that Greek bank run has nearly doubled from yesterday:
"Combined daily deposit outflows from the major Greek banks have reached 500-800 million euros over the past few days, with the pace picking up as the election draws closer and rising noticeably on Tuesday, two bankers said." This is roughly $1 billion a day in the upper case, and a number that is approaching 0.5% of the entire documented €170 billion (now likely much less) deposit base.
How much of this is fact, and how much pre-election scaremongering to scare people from voting against Syriza remains to be seen.
"Combined daily deposit outflows from the major Greek banks have reached 500-800 million euros over the past few days, with the pace picking up as the election draws closer and rising noticeably on Tuesday, two bankers said." This is roughly $1 billion a day in the upper case, and a number that is approaching 0.5% of the entire documented €170 billion (now likely much less) deposit base.
At the daily rate of doubling the "estimate" by Friday Greece will be experiencing a $4 billion in outflows. We wonder which banks will have any cash left at that point.Deposit outflows at smaller and medium sized banks were running at 10-30 million euros.
"This includes cash withdrawals, wire transfers and investments into money market funds, German Bunds, U.S. Treasuries and EIB bonds," said one banker, who spoke on condition of anonymity.
Fears that Greece may have to quit the single currency and return to a weak drachma have fuelled a steady stream of withdrawals by companies and businesses alarmed at the prospect of seeing the value of their deposits cut sharply.
The result of the election, called after a previous vote in May failed to produce a government, remains too close to call, with the conservative New Democracy party running neck and neck with radical leftist SYRIZA.
Both groups say they want Greece to remain in the single currency but SYRIZA has pledged to scrap a 130 billion euro bailout agreement signed in March which has imposed some of the toughest austerity measures seen in Europe in decades.
How much of this is fact, and how much pre-election scaremongering to scare people from voting against Syriza remains to be seen.
May 26, 2012
Greece Exit Scenarios
From Zero Hedge:
Scenario 1: Managed Greek exit; no contagion or financial market disorder
This is the most benign scenario with respect to a Greek exit, assuming away the major contagion risk. There is likely to be short term euro weakness, but a sharp initial sell-off would be deceptive and the weakness would be relatively brief once the contagion fears wore off.
Some argue that the euro would rally strongly off this development, arguing that the euro ex-Greece would be much stronger than the euro with Greece. This positive scenario would be a world in which the risk premium on other euro countries has been largely determined by the fear of contagion from a GREXIT, not issues related to other peripherals themselves. Once GREXIT occurred without damage, whether on its own or because of policy commitments, spreads would narrow and the euro would rally.
Absent such an unwinding of knock-on risk on other peripherals, the arithmetic of the euro zone divesting itself of the Greek 2% of the euro zone facing a major depreciation is not very exciting. If the new Greek currency depreciated 50% (a very round number), the implied boost to the surviving EUR with its stronger components would be about 1%, basically it’s overnight move.
The above is a very optimistic reading of what is driving peripheral spreads in other euro zone countries. If the concerns reflect risk associated with national debt in other peripheral countries, not primarily Greek contagion fears, then even if the fears abate, the fiscal concerns on remaining peripherals would prevent a major appreciation. So this benign scenario does not seem the most likely scenario by any means, nor is it likely that the euro’s problems are as Greece-centric as needed to make the euro outcome play out as described. That said, if the benign scenario plays out, EURUSD could rally significantly from current levels, trading closer to 1.45 or higher, but it just doesn’t seem very likely.
Scenario 2: Greece exits, contagion spreads to other peripherals
Greece repudiates the austerity of bailout and exits the euro zone. Contagion spreads to other peripherals.
This scenario entails months of profound economic and financial confusion during which the euro would be under constant pressure in our view. How the euro evolves depends on how euro zone policymakers deal with contagion risk and that depends on the post-departure policies that are followed.
Substantial euro downside could emerge from investor fears that other peripheral countries in the euro zone would drop out, raising the risk premium on their debt, and making it even less possible to hit fiscal and economic growth targets. A Greek dropout could be viewed as unfortunate but manageable, if the euro zone disintegration was viewed as stopping there at Greece, but the risk is that investors come to expect that other countries will follow. Such countries would experience the worst of all worlds, austerity, a risk premium that now builds in additional currency risk, but no control of exchange rate or monetary policy and no growth. Investors in that case would speculate that the cost of staying in the euro was too high for other countries as well.
The way to avoid this contagion and downward pressure on the euro would be to provide an absolute, non-conditional guarantee that no other country would drop out. This would be a spectacular transformation -- an ECB that is unwilling to act like the Fed morphs into the SNB.
Moreover, some clients have raised the possibility that investors would not believe even such a guarantee – at least not initially. They would argue that the example of Greek depreciation would induce even Mom and Pop in other peripheral countries to shift their deposits to Germany, the UK, the US or Switzerland because the downside from doing so if other peripherals do not drop out is low, and the downside from not doing so if there are further dropouts is tremendous. At a minimum this provides a big hole in peripheral banking systems that would have to be filled by the ECB – probably involving the ECB in far more open-ended risk than they have shown a willingness to take. It is unlikely that all the deposits would go to Frankfurt, so there is probably some direct downward pressure on the euro involved. The final element of the argument is that investors and residents will fear that the ECB can not bring itself to make such a permanent and potentially very expensive contingent commitment.
The EUR could begin to rally if the euro zone manages to ring-fence the other peripherals but so much damage will have been done by then that the EUR would begin its rally from a much lower level and probably not be anywhere close to the current level at the end of the year.
The optimistic view on contagion is that the ECB would not actually have to take on the risk if the commitment was ironclad enough. But if there is any degree of skepticism or if the ECB showed any hesitation, the risk-return would be in favor of capital flight and the euro would fall sharply and the ECB would face additional balance sheet risk.
This is the problem that the euro faces on any dropout scenario, Even a small country dropout that has limited direct financial and economic implications for the euro zone could raise the stakes enormously with respect to other countries. Whether the euro goes up or down depends on whether the euro zone policymakers can bring themselves to make the needed open-ended commitment and convince the market that they will stick to it thick and thin even if the price tag rises. Given their inability to achieve timely consensus on policies that would have averted the pressures and been much cheaper, investors are likely to sell euros until fully convinced of policymaker resolve.
Scenario 3: Multiple peripheral countries exit, core remains
Our economists do not see this as a high probability scenario, but it is certainly discussed by FX investors. This is the scenario in which the likely dynamics of exit conflict the most with the long-term equilibrium. Define the long term as the point at which economies and exchange rates have moved back to their long-term equilibrium path. The euro of the surviving core will likely be stronger than its predecessor euro was. Consider that the deficit, debt and external balances will be much stronger than with the current euro. So one can make the case that the long term equilibrium value of this ‘core’ euro is much stronger, possibly even at the highs that were seen in 2008.
However, the short and medium term may last for an extremely long time and the dynamics over that period are very negative, not just for the peripherals that drop out but for the core that remains in. Consider that the peripheral countries are likely to drop out one by one, probably accompanied by economic and financial disruption. The impact will be felt on core economies and financial institutions as well, so whatever the long-term equilibrium, the path there will likely be accompanied by economic weakness at least until a stable core is formed and a path to recovery is envisioned – this can take a very long time and is probably well beyond an investible horizon. The high cost to both the dropouts and the remaining core countries is one reason that this is considered such an unlikely scenario.
Scenarios that boost the euro.
Only the first scenario above has a euro positive component relatively quickly after the Greek exit is realized and the probability is low that investors will look as benignly on the event as the scenario implies.
The characteristics that each of the euro-negative scenarios share is that each reflects an augmentation of euro zone risk. Even if the risk is accompanied by a relatively hawkish ECB perspective, the euro falls because investors are focused on the deep risks associated with euro breakup rather than marginal, and probably unsustainable, gains from a hawkish ECB.. The argument we would make is that global investors will cut the euro a lot of slack if extreme tail risk can be eliminated, even if the outcome involves a bigger balance sheet or other unorthodox policies.
Scenario 4: New Greek government embraces austerity plan
We are not so naïve as to think they would actually embrace austerity, but by accepting the plan, they would relieve investors of concern in the short term of a messy default, bank runs and immediate financial crisis. Investors would not necessarily view this as a good outcome objectively, but as a better and much cheaper outcome than the alternative of messy default and Greek euro zone withdrawal. Essentially a continuation of the status quo, the question is how long a period of tranquility such a compromise would buy. If investors are jaded and view it as a very short term patch before renewed strife the bounceback in the euro would be limited.
Scenario 5: ECB bond buying or Eurobond
Both of these take a step towards resolving what is a major failure of monetary policy in the euro zone -- Interest rates are simply too high. A GDP –weighted average 10year yields of non-program euro zone countries is more than 150bps higher than in the US or UK. This effective tightness of monetary policy is hardly justified by upward inflation or growth risks.
Were the ECB to buy bonds aggressively it is unlikely that investors would fight the ECB. Were the fiscal authorities to jointly issue an Eurobond, it is likely that core yields would go up and peripheral yields down – exactly the rate redistribution required to stimulate activity in the periphery and support their asset markets. This is likely to reduce tail risk and support the euro.
Looking at these two scenarios, it seems far more likely that the SMP buying will be renewed than the governments coming together and issuing an euro bond in the near term. It seems far more likely that the trillion EUR balance expansion of the ECB since mid-2011 would have been more effective buying cash bonds than operating through the LTRO.
Having put forward these proposals, we have to admit that they seem less likely than the ECB making an effort at reviving confidence by a bog standard rate cut or an additional LTRO. The political opposition to these measures means that even though they are likely to be the most effective in resolving the crisis, they are unlikely to be the first (or second) applied.
Scenario 6: LTRO or rate cuts
It seems unlikely to us that the euro zone’s underlying problem is that the refi rate is 1% rather than 0.5%, or 1.5% for that matter. A rate cut could be seen by the market as some sort of signal that further aggressive easing was coming, but by itself it seems more likely to stimulate activity in Germany than Spain. Nevertheless, it is possible that the cut could come and that the euro could even rally if the cut was viewed as complementary to other policy actions that euro zone policymakers were planning. If the cut was viewed as a substitute for more effective measures, the euro would probably resume its fall, possibly even accelerating in its decline. To paraphrase Crosby, Stills, Nash and Young – if you can’t use the policy that works, work with the policies you have. But the euro is hardly likely to respond positively.
Similarly, a third LTRO would tread a familiar path. So far, the two earlier LTROs have eased borrowing costs at the short end and led to a shortening of duration by peripheral issuers. An LTRO with a significantly longer maturity might encourage euro zone financial institutions to buy longer dated government bonds and bring down long term interest rates. The first two helped stabilize and reduce bond yields temporarily but now they are back to where they were in the bad old days of November 2011, although not at the very peak of the crisis.
One reason the first two LTROs did not trigger a sustained drop in peripheral funding costs was the intensifying deposit flight which added to banks’ funding issues. We suspect that a pan-euro zone deposit guarantee, funded by the EFSF or ESM, could enhance the effectiveness of any future bouts of ECB lending as it will limit the outflow of bank resources. That being said, however, so far there is not much appetite for a Europe-wide safety net with the countries of the core reluctant to bankroll bank liabilities in the periphery. Moreover, the potential losses are extremely high if any country were to leave the euro zone and any country left out would almost be guaranteed to experience significant capital flight. If it could be implemented credibly (say with an ECB backstop) then the effectiveness of LTROs would not be undermined by deposit flight and banks might become more aggressive bidders for their sovereign's debt.
Potentially this could ease strains within the euro zone and generate both a global and euro zone risk rally, but to be implemented credibly would require a similar open-ended commitment to those discussed above, and such commitment have been hard to extract from euro zone policymakers.
Concluding remarks
Approaching a second round of Greek elections potential scenarios leave the balance of risks pointing towards a weaker EUR. In the long run, while there may be more favorable equilibriums, the path there we suspect will be very painful. At this stage a mixture between scenarios 2 and 6 seems most likely, with 1 a possibility on the outside – not very promising for the EUR unless policymakers surprise with decisiveness.
Scenario 1: Managed Greek exit; no contagion or financial market disorder
This is the most benign scenario with respect to a Greek exit, assuming away the major contagion risk. There is likely to be short term euro weakness, but a sharp initial sell-off would be deceptive and the weakness would be relatively brief once the contagion fears wore off.
Some argue that the euro would rally strongly off this development, arguing that the euro ex-Greece would be much stronger than the euro with Greece. This positive scenario would be a world in which the risk premium on other euro countries has been largely determined by the fear of contagion from a GREXIT, not issues related to other peripherals themselves. Once GREXIT occurred without damage, whether on its own or because of policy commitments, spreads would narrow and the euro would rally.
Absent such an unwinding of knock-on risk on other peripherals, the arithmetic of the euro zone divesting itself of the Greek 2% of the euro zone facing a major depreciation is not very exciting. If the new Greek currency depreciated 50% (a very round number), the implied boost to the surviving EUR with its stronger components would be about 1%, basically it’s overnight move.
The above is a very optimistic reading of what is driving peripheral spreads in other euro zone countries. If the concerns reflect risk associated with national debt in other peripheral countries, not primarily Greek contagion fears, then even if the fears abate, the fiscal concerns on remaining peripherals would prevent a major appreciation. So this benign scenario does not seem the most likely scenario by any means, nor is it likely that the euro’s problems are as Greece-centric as needed to make the euro outcome play out as described. That said, if the benign scenario plays out, EURUSD could rally significantly from current levels, trading closer to 1.45 or higher, but it just doesn’t seem very likely.
Scenario 2: Greece exits, contagion spreads to other peripherals
Greece repudiates the austerity of bailout and exits the euro zone. Contagion spreads to other peripherals.
This scenario entails months of profound economic and financial confusion during which the euro would be under constant pressure in our view. How the euro evolves depends on how euro zone policymakers deal with contagion risk and that depends on the post-departure policies that are followed.
Substantial euro downside could emerge from investor fears that other peripheral countries in the euro zone would drop out, raising the risk premium on their debt, and making it even less possible to hit fiscal and economic growth targets. A Greek dropout could be viewed as unfortunate but manageable, if the euro zone disintegration was viewed as stopping there at Greece, but the risk is that investors come to expect that other countries will follow. Such countries would experience the worst of all worlds, austerity, a risk premium that now builds in additional currency risk, but no control of exchange rate or monetary policy and no growth. Investors in that case would speculate that the cost of staying in the euro was too high for other countries as well.
The way to avoid this contagion and downward pressure on the euro would be to provide an absolute, non-conditional guarantee that no other country would drop out. This would be a spectacular transformation -- an ECB that is unwilling to act like the Fed morphs into the SNB.
Moreover, some clients have raised the possibility that investors would not believe even such a guarantee – at least not initially. They would argue that the example of Greek depreciation would induce even Mom and Pop in other peripheral countries to shift their deposits to Germany, the UK, the US or Switzerland because the downside from doing so if other peripherals do not drop out is low, and the downside from not doing so if there are further dropouts is tremendous. At a minimum this provides a big hole in peripheral banking systems that would have to be filled by the ECB – probably involving the ECB in far more open-ended risk than they have shown a willingness to take. It is unlikely that all the deposits would go to Frankfurt, so there is probably some direct downward pressure on the euro involved. The final element of the argument is that investors and residents will fear that the ECB can not bring itself to make such a permanent and potentially very expensive contingent commitment.
The EUR could begin to rally if the euro zone manages to ring-fence the other peripherals but so much damage will have been done by then that the EUR would begin its rally from a much lower level and probably not be anywhere close to the current level at the end of the year.
The optimistic view on contagion is that the ECB would not actually have to take on the risk if the commitment was ironclad enough. But if there is any degree of skepticism or if the ECB showed any hesitation, the risk-return would be in favor of capital flight and the euro would fall sharply and the ECB would face additional balance sheet risk.
This is the problem that the euro faces on any dropout scenario, Even a small country dropout that has limited direct financial and economic implications for the euro zone could raise the stakes enormously with respect to other countries. Whether the euro goes up or down depends on whether the euro zone policymakers can bring themselves to make the needed open-ended commitment and convince the market that they will stick to it thick and thin even if the price tag rises. Given their inability to achieve timely consensus on policies that would have averted the pressures and been much cheaper, investors are likely to sell euros until fully convinced of policymaker resolve.
Scenario 3: Multiple peripheral countries exit, core remains
Our economists do not see this as a high probability scenario, but it is certainly discussed by FX investors. This is the scenario in which the likely dynamics of exit conflict the most with the long-term equilibrium. Define the long term as the point at which economies and exchange rates have moved back to their long-term equilibrium path. The euro of the surviving core will likely be stronger than its predecessor euro was. Consider that the deficit, debt and external balances will be much stronger than with the current euro. So one can make the case that the long term equilibrium value of this ‘core’ euro is much stronger, possibly even at the highs that were seen in 2008.
However, the short and medium term may last for an extremely long time and the dynamics over that period are very negative, not just for the peripherals that drop out but for the core that remains in. Consider that the peripheral countries are likely to drop out one by one, probably accompanied by economic and financial disruption. The impact will be felt on core economies and financial institutions as well, so whatever the long-term equilibrium, the path there will likely be accompanied by economic weakness at least until a stable core is formed and a path to recovery is envisioned – this can take a very long time and is probably well beyond an investible horizon. The high cost to both the dropouts and the remaining core countries is one reason that this is considered such an unlikely scenario.
Scenarios that boost the euro.
Only the first scenario above has a euro positive component relatively quickly after the Greek exit is realized and the probability is low that investors will look as benignly on the event as the scenario implies.
The characteristics that each of the euro-negative scenarios share is that each reflects an augmentation of euro zone risk. Even if the risk is accompanied by a relatively hawkish ECB perspective, the euro falls because investors are focused on the deep risks associated with euro breakup rather than marginal, and probably unsustainable, gains from a hawkish ECB.. The argument we would make is that global investors will cut the euro a lot of slack if extreme tail risk can be eliminated, even if the outcome involves a bigger balance sheet or other unorthodox policies.
Scenario 4: New Greek government embraces austerity plan
We are not so naïve as to think they would actually embrace austerity, but by accepting the plan, they would relieve investors of concern in the short term of a messy default, bank runs and immediate financial crisis. Investors would not necessarily view this as a good outcome objectively, but as a better and much cheaper outcome than the alternative of messy default and Greek euro zone withdrawal. Essentially a continuation of the status quo, the question is how long a period of tranquility such a compromise would buy. If investors are jaded and view it as a very short term patch before renewed strife the bounceback in the euro would be limited.
Scenario 5: ECB bond buying or Eurobond
Both of these take a step towards resolving what is a major failure of monetary policy in the euro zone -- Interest rates are simply too high. A GDP –weighted average 10year yields of non-program euro zone countries is more than 150bps higher than in the US or UK. This effective tightness of monetary policy is hardly justified by upward inflation or growth risks.
Were the ECB to buy bonds aggressively it is unlikely that investors would fight the ECB. Were the fiscal authorities to jointly issue an Eurobond, it is likely that core yields would go up and peripheral yields down – exactly the rate redistribution required to stimulate activity in the periphery and support their asset markets. This is likely to reduce tail risk and support the euro.
Looking at these two scenarios, it seems far more likely that the SMP buying will be renewed than the governments coming together and issuing an euro bond in the near term. It seems far more likely that the trillion EUR balance expansion of the ECB since mid-2011 would have been more effective buying cash bonds than operating through the LTRO.
Having put forward these proposals, we have to admit that they seem less likely than the ECB making an effort at reviving confidence by a bog standard rate cut or an additional LTRO. The political opposition to these measures means that even though they are likely to be the most effective in resolving the crisis, they are unlikely to be the first (or second) applied.
Scenario 6: LTRO or rate cuts
It seems unlikely to us that the euro zone’s underlying problem is that the refi rate is 1% rather than 0.5%, or 1.5% for that matter. A rate cut could be seen by the market as some sort of signal that further aggressive easing was coming, but by itself it seems more likely to stimulate activity in Germany than Spain. Nevertheless, it is possible that the cut could come and that the euro could even rally if the cut was viewed as complementary to other policy actions that euro zone policymakers were planning. If the cut was viewed as a substitute for more effective measures, the euro would probably resume its fall, possibly even accelerating in its decline. To paraphrase Crosby, Stills, Nash and Young – if you can’t use the policy that works, work with the policies you have. But the euro is hardly likely to respond positively.
Similarly, a third LTRO would tread a familiar path. So far, the two earlier LTROs have eased borrowing costs at the short end and led to a shortening of duration by peripheral issuers. An LTRO with a significantly longer maturity might encourage euro zone financial institutions to buy longer dated government bonds and bring down long term interest rates. The first two helped stabilize and reduce bond yields temporarily but now they are back to where they were in the bad old days of November 2011, although not at the very peak of the crisis.
One reason the first two LTROs did not trigger a sustained drop in peripheral funding costs was the intensifying deposit flight which added to banks’ funding issues. We suspect that a pan-euro zone deposit guarantee, funded by the EFSF or ESM, could enhance the effectiveness of any future bouts of ECB lending as it will limit the outflow of bank resources. That being said, however, so far there is not much appetite for a Europe-wide safety net with the countries of the core reluctant to bankroll bank liabilities in the periphery. Moreover, the potential losses are extremely high if any country were to leave the euro zone and any country left out would almost be guaranteed to experience significant capital flight. If it could be implemented credibly (say with an ECB backstop) then the effectiveness of LTROs would not be undermined by deposit flight and banks might become more aggressive bidders for their sovereign's debt.
Potentially this could ease strains within the euro zone and generate both a global and euro zone risk rally, but to be implemented credibly would require a similar open-ended commitment to those discussed above, and such commitment have been hard to extract from euro zone policymakers.
Concluding remarks
Approaching a second round of Greek elections potential scenarios leave the balance of risks pointing towards a weaker EUR. In the long run, while there may be more favorable equilibriums, the path there we suspect will be very painful. At this stage a mixture between scenarios 2 and 6 seems most likely, with 1 a possibility on the outside – not very promising for the EUR unless policymakers surprise with decisiveness.
May 20, 2012
Volcanoes eruptions that could change the world
1. KATLA (Iceland)
Last erupted: 1918
Effects of a major eruption: If Katla goes off, its eruption will be 10 times stronger than Eyjafjallajokull's. Katla's larger ash plume would shoot higher in the air and spread over larger areas of Europe for a longer period, with much more devastating effects on air travel and economic trade. An eruption could tip Europe's economy — perhaps even the world's — back into severe recession or a depression.
Likelihood: Fairly high. The two volcanoes, only 12 miles apart, tend to erupt in tandem, and Katla is slightly overdue in its 80-year cycle.
2. CUMBRE VIEJA (La Palma, Canary Islands)
Last erupted: 1971
Effects of a major eruption: In 2001, U.S. and British scientists warned that a major eruption of Cumbre Vieja could cause the enire western flank of the volcano to fall into the sea, creating a "mega-tsunami" in the Atlantic. Traveling at 500 miles per hour, it would wipe out Florida, coastal Brazil, and parts of Europe with waves up to 160-feet high.
Likelihood: The scientists say the "year to year probability" of a major eruption is low, but preparations should be taken anyway given the potentially cataclysmic damages.
3. MT. VESUVIUS (Italy)
Last erupted: 1944
Effects of major eruption: Famous for wiping out Pompeii and Herculaneum in 79 A.D., Vesuvius would do much greater damage today. About 3 million people live near the volcano, 600,000 of them in the "red zone." An eruption would kill at least 8,000 people and cause more than $24 billion worth of damage, according to Willis Research Network, which just named Vesuvius the most dangerous volcano in Europe. The ash would change weather patterns in Europe and leave the Naples area a "lifeless desert."
Likelihood: Scientists say Vesuvius is overdue for an explosion.
4. POPOCATÉPETL (Mexico)
Last erupted: 2000
Effects of a major eruption: The third-tallest active volcano in the Northern Hemisphere, Popocatépetl is only 40 miles west of Mexico City and its 18 million inhabitants, and 30 miles east of Puebla, a city of two million. A large eruption could send deadly mudslides into the populous valleys below, creating "catastrophic" loss of life.
Likelihood: After an 80-year dormant period, Popocatépetl is showing signs of activity.
5. MT. TAMBORA (Sumbawa, Indonesia)
Last erupted: 1967
Effects of a major eruption: Tambora erupted in spectacular fashion in 1815 and changed weather patterns around the globe, causing "frosts in Italy in June and snows in Virginia in July, and the failure of crops in immense swaths across Europe and the America." The blow-up killed more than 71,000 people directly, and many more through famine and sickness.
Likelihood: Tambora is still active and, given its history and Indonesia's 222 million inhabitants, closely monitored.
6. YELLOWSTONE "SUPERVOLCANO" (U.S.)
Last erupted: 640,000 years ago
Effects of a major eruption: When the Yellowstone Caldera, or "supervolcano," in Yellowstone National erupts again, it will render a huge swath of North America, from Vancouver to Oklahoma City, uninhabitable. It would have incalculable human and economic consequences. The last eruption of similar magnitude — 73,000 years ago in Sumatra — plunged the entire planet into a decade-long volcanic winter and nearly wiped out the human race.
Likelihood: Geologists see signs that it could be preparing for another major blowout soon, although "soon" could mean thousands of years.
May 16, 2012
Greece banking system is officially bankrupt
The latest opinion polls, as per Credit Suisse, show Syriza soar from 52 seats to a hugely dominant 128 seats.
Greece After Elections - current opinion polls...
Just few hours ago this was the biggest danger to the Eurozone a left party willing to reject the current status quo and repudiate previous contracts.
But things have been moving fast and ECB President Draghi just admitted that while the ECB Governing Council would like Greece to stay, they will not take any further extraordinary measures to save it.
Bloomberg: Draghi Signals ECB Won’t Keep Greece in Euro Area at Any Cost
European Central Bank President Mario Draghi indicated that while his “strong preference” is that Greece stays in the euro area, the bank won’t compromise on its principles to prevent an exit.
“The ECB will continue to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet,” Draghi said in a speech in Frankfurt today. Since the euro’s founding treaty does not envisage a member state leaving the monetary union, “this is not a matter for the Governing Council to decide,” Draghi said.
The comments are the closest Draghi has come to conceding Greece could leave the euro region. Greece faces a fresh election on June 17 that may boost parties opposed to the conditions of its international bailouts, raising the specter of its exit.
“The Governing Council’s strong preference is that Greece will continue to stay in the euro area,” Draghi said.
What does it mean it became just to clear when Reuters came out with the following piece of news:
From Reuters:
What it means is that we are practically witnessing an attempt to control the default of Greece and the bankruptcy of its banking system which in a matter of hours or days unless by hook or crook something is implemented will happen.The European Central Bank has stopped monetary policy operations with some Greek banks as they have not been successfully recapitalized, euro zone central bank sources said on Wednesday.
The ECB declined to comment.
The ECB only conducts its refinancing operations with solvent banks. With no access to ECB funds, the banks concerned must go to the Bank of Greece for emergency liquidity assistance (ELA).
It was unclear exactly how many banks were affected.
One person familiar with the matter said four Greek banks' capital was so depleted they were operating with negative equity capital. According to its own rules, the ECB cannot provide liquidity to banks in such a situation.
Greece cannot bailout its banks, we are facing a total collapse of a banking system unless a sudden injection of money will materialize from somewhere.
Eventful days worth being monitored closely not only for Greece but for the entire world economy.
March 25, 2012
Eurozone Unsustainable Debt could bring Germany to leave the Euro
Eurozone crisis can has been temporarily frozen by the ECB but is on track to come back home with a revenge. There are many signs that the ECB intervention could have actually made things worst in exchange for some months of relative calm on the markets. Let us not forget that as far back as September 2011, PIMCO’s Co-CIO, Mohamed El-Erian (one of the most connected of the financial elite) noted that French Banks were running REAL leverage levels of almost 100-to-1.
El-Erian said French banks are a particular
cause for concern, noting that "credit markets now put their risk of
default at levels indicative of a BB rating, which is fundamentally
inconsistent with sound banking operations." He adds that bank equity
now trades at a 50% discount to tangible book value on average, while the ratio of market capital to total assets has fallen to 1%-1.5%, compared with 6%-8% for "healthier banks."
The ECB managed to swap out its Greece debt into new debt. But it won’t be able to do this with the remainder of PIIGS’ debts. Instead, the ECB plans on shifting any of the losses from these debts onto the individual EU national banks:
ECB Balance Sheet Jumps Above €3 Trillion
The mix of bond purchases and loans has
exposed the ECB and the 17 national central banks that make up the euro
to losses in the event of defaults or bank failures. Last month, the ECB
was forced to swap its €50 billion Greek bond portfolio for new bonds
to shield the banks from potential losses in the event of any forced
write-downs.
If banks that have borrowed from the ECB
can't pay the money back and the collateral they have posted falls in
value or becomes worthless, the ECB would be on the hook for losses. Most
of these losses would be spread across national central banks according
to their size, meaning Germany's Bundesbank would face the largest
exposure.
Germany is certainly aware of this since it has already put up a firewall that would allow it to walk out of the Euro at any point. Obviously it doesn’t want to, but when the ECB will try to shift the losses from its PIIGS exposure onto Germany’s shoulders, Germany will have no choice. The reality is that the ECB is far too small to cover the astonishing amount of debt a look at the chart below gives an idea of what kind of figures we are talking about.
A solution would be for the ECB to start printing money but it is blocked form doing so from Germany who made clear will walk away from the Euro rather than trigger an hyperinflation.
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