The Crisis for the Euro and what Argentina’s experience can teach Greece

After the “shock and awe” aid package of the euro zone last Sunday night/Monday morning was announced we saw rallies in quite a few markets. Equity markets around the world surged on Monday and posted quite considerable gains, the Euro strengthened against the US $ and even the sovereign debt of Greece, Portugal, Ireland and Spain saw a rally as the European Central Bank began on Monday morning its new programme of purchasing them. So at first events seemed to be following the path of the euro zone defeating what they call the “wolf pack” and that evening the French Finance Minister Christine Lagarde appeared on the BBC’s Newsnight programme to crow about the success of her plan. However one phrase was used a lot by ministers and officials and it was “save the Euro” and indeed it briefly rallied above 1.30 versus the US dollar. However  the Euro was sold as a currency throughout the week culminating in an 18 months low for it on Friday as pressures accelerated and this morning it is even lower at 1.228 versus the US dollar.

What has caused this?

There are several factors in the fall of the Euro exchange rate.

1. In terms of economic competitiveness the Euro zone actually needs a fall in its exchange rate. Countries such as Greece Portugal and Ireland need every bit of economic competitiveness they can find. Indeed the previous rally in the Euro was harmful to the economic competitiveness of the euro zone and was one of the causes of the sovereign debt crisis for the euro zone. To their credit markets have realised this and are pushing the Euro lower. So the politicians with their cries of “wolf pack” and (evil) speculators are fighting the wrong enemy with their rhetoric. Sadly with their poor track record in economic understanding I do no expect this to be the last time in this episode that they do this. Currency machismo is not what is required at this time.

So here is a thought for you often ignored, for the euro zone the fall in the Euro is a part of the adjustment mechanism that is required. Let us see when politicians wake up to this.

2. The “shock and awe” package has quite a few weaknesses in its composition. If you break down the 750 billion Euros you end up with a package of approximately 60 billion Euros which is probably backed by 30 billion Euros from the International Monetary Fund. I think the hyperbole and grandstanding  in this has hit home. For example as the week developed David Lipski who is the Deputy Head of the IMF pointed out that it does not ring-fence sums of money for particular areas which questions 250 billion Euros of the funds. Also the Special Purpose Vehicle (SPV) which in theory would provide 440 billion Euros would take ages to activate and is something that could have been done in that time frame anyway. I wonder if it will ever be used. After all look at the trouble a 8.3 billion Euro contribution from Germany to Greece (later raised to 22 billion) caused in Germany. Does anybody actually believe that Germany would now pay around 120 billion Euros to the SPV? Anyway the “shock and awe” fund has nothing to do with the Euro exchange rate.

3. Moves made recently with the European Central Bank have reduced its credibility. Its President Mr. Trichet stated in January 2010 that its collateral rules would not be changed to benefit one country and in the past was very critical of the US Federal Reserve and the Bank of England for their Quantitative Easing Policies. He has now done the former and has started on the path towards the latter which I will discuss more later.

4. I also think that a more fundamental problem is troubling markets. For the stability package to work it needs a form of austerity and conditionality but these are likely to reduce economic growth in several areas in the euro zone. Yet what these parts of the euro zone most need is economic growth if they are to recover from this sovereign debt crisis. So there is a clear logical inconsistency in the rescue package.

Greece and Argentina’s experience

For those of you are unaware Argentina went through a similar experience to that of Greece back in 2001/02 and was the most recent experience of this type. Recently the Argentinian  President Cristina Fernández offered this opinion on the involvement of the IMF in Greece ” “the same recipes they applied to us, which provoked  2001” and that the plan would have “terrible consequences” for Greece. In case you are wondering Argentina defaulted on her debts in 2002.

If you compare Greece with Argentina you quickly come to the conclusion that Greece now is in a worse position than Argentina was in back in the late 1990s which led to her default in 2001. For example Greece has a much higher level of indebtedness,she is more uncompetitive in world markets and the adjustment required in her fiscal position is higher. To put this into numbers here are some comparisons.

1. In terms of percentages of Gross Domestic Product Greece has a national debt of around 120% whereas Argentina had one of 62% in 2001.

2. In terms of fiscal deficit Argentina’s was just over 6% of GDP whilst Greece’s has just peaked at 13.6%

3. If you use a current account deficit as a measure of economic competitiveness then Argentina’s was under 2% of GDP whilst Greece’s is around 11%.

So as you can see the IMF is being asked to sort a situation which is worse than one in which it failed…. There have been IMF papers written on this subject which suggest that a way out of this conundrum is a debt restructuring but the politicians of the euro zone will not countenance this for fear of contagion.

Greece and Economic Growth going forwards

There is a further problem for Greece as time passes. Regular readers will know that I think that official forecasts for economic growth in Greece have been too optimistic. Indeed the European Commission has recently published two different growth forecasts which is a good effort. However both are too optimistic as they only expect Greece’s GDP to fall by 3 or 4% respectively this year. Based on my analysis of Latvia’s experience in the hands of the IMF I feared that the number would be worse than this at say 6%.

However I have seen some analysis done by Daniel Gros (an economist who specialises in this area) who has done a calculation for how much he expects Greek economic output to fall for each 1% reduction in its fiscal deficit. His analysis leads him to believe that  for each 1% of GDP decline in Greek government spending, economic output in Greece will fall by 2.5% of GDP. So if you put in a fiscal adjustment of 10% you get a fall in GDP of 25%. Now the analysis is a little simplistic but it is revealing as to the depths of recession we can expect and I feel it will be worse much worse than is being factored in now. You see if anything like this happens (and it is consistent with the experience of Latvia) then the numbers the IMF has calculated for a stable path for Greece simply fall apart. Having previously thought that Greece’s GDP could fall by 6% this year I now fear that it could fall by more and that next year is likely to be as bad.

Mr. Gros has also done an analysis of Greece’s austerity programme and he feels that some of it is simply not credible, so we can expect disappointments on this front too.

The European Central Bank

This has been a very difficult period for the ECB and the about turns forced on it by Europe’s politicians have damaged its credibility severely. However if we look at what has happened since the “shock and awe” announcement I think that we have further problems.

1. It has promised to sterilise its sovereign bond purchases but so far it has not. So at this moment in time we have full-blown quantitative easing in the euro zone.

2. It has not announced how much peripheral sovereign debt it will buy. To my mind this means that it does not know. It started to buy last week and bond prices in the relevant countries rose. However after a rumoured 20 billion Euros of purchases it stopped buying and on Friday peripheral bond yields rose again. For example in terms of ten-year government bond yields Greece rose from 7.47% to 8.28% and Portugal’s rose from 4.68% to 4.93%, even Spain’s rose from 3.97% to 4.07%.

So the minute it steps back yields rise again which means that one hope for the programme that it can buy and then step back has gone. If the ECB remains forced to keep buying when will it stop and how much will it eventually buy? We could end up with a socialization of peripheral sovereign debt and this crisis which has seen private sector debt moved onto public sector balance sheets is now seeing movements in public-sector balance sheets from the imprudent to the prudent. Yet another moral hazard.

There should be some more detail from the ECB on what it has done so far tomorrow and I wait to see it but compared with the Bank of England it has been much less transparent about its bond purchases so far.


The more I analyse Greece’s situation the more I feel that the rescue package for her is in fact a trap rather than a solution. The failure to incorporate a form of debt restructuring is likely to prove fatal to her efforts to get out of her current problems and may even lead to her defaulting. Perhaps the worst part of this is the continued troubling feeling that the whole policy is simply to move the problem to a time which will be more convenient for the European banking sector and that Greece and her people are merely a pawn in this game of realpolitik.

I have written before about the dangers for the balance sheet of the European Central Bank in her plan to purchase peripheral sovereign debt. She already had a balance sheet that was the lowest quality of the main central banks of the world. Last weeks developments when she stopped buying peripheral sovereign debt suggest that this programme is going to have to be larger than she expected and so her balance sheet quality will deteriorate further. A question comes to my mind, has anybody asked Europe’s taxpayers? After all there could be big bills coming from this if it goes wrong….

On a lighter note as a child I grew up watching Captain Scarlet. Therefore everytime I hear the letters SPV I think first of a Spectrum Pursuit Vehicle and not the new Euro fund. If Europe’s politicians and officials did not ever watch this programme they could probably do with a man who is indistructable or were they hoping their policy would acquire a similar sheen? And are market forces and speculators Mysterons in their mind?

Also there was a cautionary note for those expecting further short-term falls in the Euro exchange rate yesterday. You see the business section of the Sunday Times opened with a headline expecting it to go to parity with the US dollar. Having observed this paper over many years I have come to the conclusion that when it does this much more often than not it turns out to be a reverse-indicator.


18 thoughts on “The Crisis for the Euro and what Argentina’s experience can teach Greece

  1. Very effective analysis of the problems, Shaun. May I clarify one point? “…this crisis which has seen private sector debt moved onto public sector balance sheets is now seeing movements in public-sector balance sheets from the imprudent to the prudent. Yet another moral hazard.” We know what you mean, but surely it should be “debt movements” in the latter phrase also to be clear? If there were credit movements from imprudent to the prudent that would not be the problem.

    Also, I feel that you are being somewhat over optimistic in the phrase “…but compared with the Bank of England it has been much less transparent about its bond purchases so far.” The present UK government is reported to be discovering the expected (by some) skeletons in the cupboard left by the last UK government, relative to undeclared last minute spending commitments and contract agreements. I suspect based on the increasing evidence that the amount of QE announced and admitted to have been injected by the BoE may be understated. Being under the close control of the previous government, rather than being independent, there is no reliable way of actually determining the total amount of QE which has been injected, if the BoE under instruction from the last government did not admit it. (In the past when UK governments have used the Inflation tool to balance their budgets, they have never made any announcement of the amounts injected.) Indeed, if it had have been significantly larger than stated this would not have been announced, for fear of panicking the markets.

    I believe that TRUTH is something of an entrenched habit; the converse is that lying and deceit is a similar habit. We have seen that the last UK government became the paragon of lies and deceit, most of all in its deliberately distorted and manipulated published statistics! It is most unlikely therefore that based on track record the published number for the total injection of QE would have been any more truthful than any other of their statistics. The BoE has in any case latterly been much less disciplined and less transparent than the ECB was until EU politicians took away the ECB’s remaining independence, mainly because the ECB was originally modeled upon the Bundesbank.

    • I beg your pardon. I thought that ‘lies’, ‘deceit’, ‘manipulated published statistics’ is an attribute reserved to Greeks.

      • No.. solely reserved for ALL politicians no matter their nationality.

        .. and the new bunch in the UK will continue where the others left off.

  2. On a lighter note as a child I grew up watching Captain Scarlet. Therefore everytime I hear the letters SPV I think first of a Spectrum Pursuit Vehicle and not the new Euro fund. If Europe’s politicians and officials did not ever watch this programme they could probably do with a man who is indistructable or were they hoping their policy would acquire a similar sheen? And are market forces and speculators Mysterons in their mind?

    So does that make Trichet Captain Black?

  3. If I have taken over a responsible position and the previous incumbent had left me a note saying, ‘’sorry no money left, he he’’ somebody would be looking to get a smack on the chin!

    Some pretty inflamed language used when the new guys finally got to see the books, ‘slash and burn policy by the previous administration.’……..

    Trichet a laddo ain’t he, telling the Germans how right he has been all along about the need to pay down debt piles. He is now pilling debts onto debts, welcome to the Anglo Saxon business model Mr T!

  4. God forbid a large part of the EU goes thru what Argentina or Latvia did.. it was essentially a depression for a number of years. Worst part is, they look set for a repeat performance along with a couple of other Latin countries.. Venezuela and Ecuador in particular. I can say with relative certainty that the Greek population will not lightly tolerate such catastrophe. By your numbers, both the US and UK are now worse than was Argentina as well.

    Today’s action in the stock and currency markets strongly smell of central bank manipulation; there was a brief moment when volume spiked and the DOW tanked badly; the euro was already well below $1.23. It was at this moment that Bernanke’s beeper went off and “the call” was made to the shady trenchcoat dudes in the basement to start “corrective actions”. Most market vets know this is the drill. But my question is.. how long can and/or will they continue rescue operations ?

    • Hi Mr.K
      It is interesting that you felt that there was some intervention at that point. Just in terms of the currency if I was intervening I would declare it as for once (and for once only..) bluster etc. can be a weapon. The most successful central bank currency interventions have worked that way in my experience and in this case you would have to line up all the main central banks. So if they did do it secretly I think they made a mistake… As to a limit for currency intervention well you cannot supply dollars for ever with nobody spotting it although of course monetary aggregates are currently so confused you probably could hide things for a while if you wanted too.
      As to equity markets there seems to be no end of tricks and ruses they will try to help them rally. After talking for many years about a Greenspan put I now find myself in an era where we have a Bernanke put and a Trichet put and after the sequence of inflation numbers in the UK a King put too!

  5. The free fall of the Euro has hit my personal finances quite a bit. Took some 15% austerity myself since the beginning of the year. Being paid in Euros and having bills in Dollars… I am wondering now, should I stage a wild and dramatic protest at the Greek embassy next week to show my outrage over the austerity the Greek government has pushed upon me? Is there a big Greek union that can hand me some irresponsible slogans that actually brake down the fabric of society for the benefit of their members instead of help the nation progress? A slogan that goes something like: good times for workers in my branch, I care for me and surely don’t care for all the other people! Oh well, if the ash cloud does not affect my flight plans, I will be back in the Netherlands next week. Our socially aware unions who more or less work constructively with the employers and which have members in all branches (public and private) seem like a gift from heaven right now. They negotiated austerity without the government even breaking a sweat. Focusing on employment rather than benefits, the 4% unemployment rate in the Netherlands is their proof. Will there ever be a Greek union like that? I wonder.

    Now back on topic:
    The exporters in the Euro zone have been celebrating the drop in the Euro as if salvation day has come (Given what I read in Dutch and German newspapers). And some reports show that on the other end Euro zone importers have started canceling orders as well. I am not sure if Greece, Spain and Portugal can profit substantially from this shift. I fear the bulk of the market share will probably be scoped up by the already strong members. But it might help some more Euro zone nations to export themselves somewhat out of the trouble zone.

    Shaun, does this import drop versus export rise trend mean that all growth forecasts for the Euro zone need readjustment? Or is this shift too small to really mater in 2010? Or will it cause an upswing in the Euro in the near future?

    • ‘Focusing on employment rather than benefits’
      Have lived for years in the Netherlands. Many benefits, I had a Dutch friend who was complaining about the tax he was paying on his generous unepmployment benefit. Compared to Holland, Greece has no benefits (have lived also for years in Greece). You cannot compare the two countries for many both objective and subjective reasons, first neighbourhood, opportunities for trade, threats of national security, history, mentality etc. etc. Black and white. My subjective opinion, if I had enough money, I would prefer 100% to live in Greece than in the Netherlands by far! Just more interesting country, outdoor culture and the glorious sun! If I was living on benefits though I’d better stay north.

      • Hi Basil, first of all, I like Greece and wish it all the best. But I, of course, would prefer 100% to live in the Netherlands. 🙂 I was just briefly venting my frustration at my rapidly and ever faster growing bills. I am kind of at the wrong end of the currency trade right now. And the actions of the Greek unions are just so alien and weird to me, but that is probably a cultural thing as well.

    • As we are nearly half way through 2010 now and the Euro fall has been ongoing throughout this time it will probably be a while (allowing for J curve and reverse J curve effects) before the gain from this shows up. So we should see some impact in Q1 and Q2 2011 building up through the year. I would expect most growth that comes in exports to be a response to world growth for 2010 with only a small impact if at all from the Euro fall.

      As to individual effects I would expect Germany and the Netherlands to do much better out of this than the countries in trouble. So whilst it is good news it comes with a sting in the tail as it is likely to exacerbate economic divergence in the euro zone. So far I have not seen any official suggestion which even accepts this problem let alone tries to deal with it.

  6. Hi Shaun, another question; “when will the Chinese housing bubble burst?”
    Prices are so inflated right now that some major Chinese cities have housing prices comparable to New York and London, while income per person is only one tenth of that of the persons in those cities. Here is a nice clip. Almost 200k Dollars for 550 square feet in a Chinese city neighborhood. If you ask me, the entire building is not even worth 5 cents.

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