Greece, Spain, and the Euro Trojan Horse

We have written and commented on Greece and Spain as well as Iceland, Italy, Ireland, and Portugal.  This week saw a rash of sovereign debt credit default swap speculation driving the costs of CDS for Greece, Spain, and Portugal higher as well as other countries, including the United States.  The speculation is another example of the need for derivatives regulation and a transparent trading and recording market.  The fear of sovereign debt default by a European Union Euro currency nation is a wasted exercise, unless you are profiting from the same type of unregulated speculation which helped bring Bear Stearns and Lehman down and drove Merrill Lynch and Morgan Stanley into larger, more systemically dangerous relationships.

The problems in Greece and Spain are vastly different, but both are derived from the Euro.  Greece and Spain both suffer from a competitiveness gap in that their Euro exchange rate is overvalued while surplus exporting countries, like Germany, have an undervalued exchange rate.  Greece has tourism, shipping, agriculture, and banking, with an aggressive exposure to emerging Eastern Europe, as economic engines combined with an aging demographic population and falling birth rate.  The immediately prior Greek government also soured relations with the EU by supplying economic information which was not correct leaving the current Greek government with testy EU demands.  Given the lack of industrial economic growth and exports, Greece has less immediate but longer term problems.

Spain has more immediate problems.  The Euro caused negative interest rates in Spain from 2002 to 2006, which caused massive economic overheating during which Spain became the largest issuer of covered bonds in Europe driven by the mortgage market. These Cedulas are secured by mortgage loans on domestic properties issued by any Spanish bank or savings institution.  In some instances, they are participation securitizations in which the holder is entitled to only a percentage participation.  Under Spanish law, unlike the Phandbriefe in Germany, Spain undertook the largest departure from the German bond model and it is less demonstrable that investors could lay hands on the assets in the event of issuing institution insolvency.  When the current global financial crisis caused lending to cease in Spain in August of 2008, it was as if the whole financial system had seized up.  The question has become to what extent the government may have to act if the individual issuing institutions do not have the ability to make these covered bonds good in the future.  This would be a serious European problem, because, in over 200 years no Phandbriefe has ever defaulted. The financial seizure in the financial sector and the bursting of the mortgage asset bubble has created significant unemployment. Nationally, unemployment is in excess of 19% and youth unemployment (16+) is 44.5%.  The unemployment situation places a much more immediate pressure on the Spanish problem.

If Spain or Greece had their own currency, they would have more ability to apply fiscal and monetary policies to stimulate their economies and create employment. The speculative attack on their ability to issue bonds at reasonable yields is an unwarranted attack on their sovereignty, because the actual target of the attack is the Euro and is fueled by EU rules which require member nations to have only 3% debt to GDP without respect to the Euro competitiveness gap or internal national economic conditions.  Both countries should be increasing public spending to target economic growth and job creation, but they are being forced by the EU to reduce their budget deficits.  These enforced budget austerity programs are both reducing public sector wages.  This will fuel deflation.  Prior to the global financial crisis, Spain had a surplus.  The 2010 deficit estimate is 9.8% of GDP. 7.5% in 2011, 5.3% in 2012 with an austerity program which will cut $70.1 billion.  Despite the high unemployment, the people of Spain have not yet realized the fate to which the EU is consigning them.

In Greece, it is another story.  General strikes are already planned for February 10 and 24.  It is estimated that the EU enforced austerity program will accelerate the decline in Greek GDP from <1.7%>; to <7%>;.  Greek unemployment, presently 8.3%, will increase by another 300,000 as a direct result.  Does the EU really want to promote social disturbances in Greece and have them spread to Spain and then to Portugal, with its politically divided government?  Greece is raising its fuel tax.  Lower public spending, higher taxes, lower wages, and increasing unemployment are not the economic drivers the EU should be forcing on these countries.  Greece needs more budgetary control given the historical level of corruption which means spending should be efficiently targeted to spur economic growth and jobs.  Despite those deficit hawks who would drive countries into depression, public debt is not the same as private debt and it is private debt fueled by unregulated derivatives speculation which has caused this global financial crisis.  To turn our focus away from needed financial regulatory reform to an an unwarranted sovereign debt default fear which has been promoted by derivatives speculators is intolerable.  Are we to allow the derivatives speculators to become the new terrorist overlords?

There has been much gratuitous talk of bailing out Greece and how the EU will not bail out any member nation.  In fact, the legal authority exists for the EU to bail out a member nation, but it is not necessary.  All that is required is that the EU provide loans which will target economic growth and jobs and revise its monetary policies to more appropriately take into consideration the competitiveness gap of the Euro exchange and the actual internal economic conditions of each member country.  To force a debt to GDP rule down a countries throat when it needs to increase public spending is asking for economic turmoil.  To the extent, that some countries budget deficits have been inefficiently expanded by corruption or incompetence is an issue which needs to be addressed by targeted, efficient public spending.  The problem with the EU providing loans is the surplus EU countries, like Germany , who benefit from the Euro competitiveness gap, are not going to want to share in the risk.

Yet, there are European rumors that large French and German banks have significant exposure to Greek debt. Greek banks have used Greek debt as collateral on loans from (repos)  the ECB, but the ECB, at the end of 2010, will no longer accept collateral with less than an A credit rating, which Greek bonds no longer have.  Currently, there is every expectation that market pressures will continue and, perhaps, grow.  All of this makes it all the more important for the EU and ECB to quickly formulate a loan plan for targeted spending in Greece and Spain, as well as any other Euro competitiveness gap country with similar problems, such as Portugal and Italy.

Much has been made of the IMF providing money to Greece as the preferred process and the IMF has indicated it would be willing to work with Greece, but Greece has not approached the IMF.  In as much as these problems in Greece and Spain have been at least partially caused by the Euro, I do not see the EU wanting the IMF to help Greece.  Additionally, the EU and the ECB need to face up to the need of the Euro to be responsive to the economic conditions of the member nations and the need to address the Euro competitiveness gap.  The EU has studied the possibility of issuing EU bonds since at least 2000 and this current situation is just the reason the EU and ECB should quickly develop an EU bond program and begin issuing EU bonds.

If EU member nations using the Euro are not able to apply fiscal and monetary policy, because they no longer have a national currency, then the EU and the ECB need to develop the monetary policy tools to allow their member nations to apply appropriate fiscal policies to best serve their citizens.

The possibility of default is speculative hoopla and deficit hawk destructiveness.  While deficits need to be controlled,  targeted public spending grows an economy and the withdrawal of public spending constricts an economy.  At the present time, Greece and Spain need targeted spending and financial regulatory reform.  Default is not a plausible option given the domino effect.

Note:  I am aware that the EU currency is spelled euro and not capitalized, but I have chosen to capitalize it to emphasize that it is a currency of 16 nations and, as such, it faces the problems a global currency would have to resolve.


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