Friday, May 18, 2012

Facing Reality

European leaders add to rising fears of breakup
European officials are playing a dangerous game of chicken with Greece.

In an apparent signal to Greek voters, the head of the World Bank warned Thursday that if Athens were to depart from the common currency, Spain and Italy could well be the next dominoes to fall in Europe’s widening financial crisis.

After ousting the Athens government that agreed to deeper spending cuts in return for a financial lifeline, voters return to the polls in June after the winning parties failed to form a new government. Apparently hoping to convince Greek voters to return a pro-austerity government to power, European officials are now openly discussing the likely dire consequences if they don’t.

But the comments may have only served to heighten fears of a wider breakup of the eurozone should Greece exit the monetary union. Investors backed away further from Spain's government debt Thursday, raising the country’s borrowing costs to levels that sparked the Greek debt crisis in the first place. Bond buyers were also reacting to fresh economic data showing that Spain’s economy is beginning to shrink, which makes its existing debt load even harder to carry.

The growing crisis also has caused growing nervousness among U.S. investors. Since the inconclusive Greek vote May 6, the Dow Jones industrial average has fallen in seven out of eight sessions and was down again Thursday. U.S. banking giant JPMorgan Chase send another ripple of worries through the market May 10 when it said it had lost at least $2 billion in a failed attempt to hedge against European volatility.

The recession is also putting more pressure on Spain’s banks, which have been saddled with bad mortgages as the country faces a deepening housing bust. Last week, the government took over Bankia, which holds 10 percent of the banking system’s deposits, after it reportedly suffered an large outflow of deposits.

The news follows reports that depositors pulled another $900 million out of Greek banks on Wednesday, extending a capital flight that could bring down Greece’s banking system. The fear is that those worries spread among depositors in other countries like Spain where the banking system is already under pressure.

Until very recently, European officials were loath to even discuss the idea of Greece’s departure from the compact binding 17 nations with a common currency. For one thing, the treaty that created the euro has no provision for a member country to abandon the currency or for its expulsion by the rest of the monetary union.

But central bankers and officials of agencies like the World Bank and International Monetary Fund have begun to think – and discuss – the unthinkable.


Analysts who are looking at the potential impact say the losses and economic pain would be widely felt.
Replacing the euro with a new, devalued currency would wipe out much of the remaining assets on Greek bank books. Europe’s central bankers have already pulled back some forms of funding for Greek banks that have been hit hardest by withdrawals.


Any new currency – or a return to the pre-euro drachma – would be massively devalued, by some estimates as much as half the value of a euro. That would help Greece’s economy eventually get back on a growth path because it would make its products and services cheaper for buyers spending dollars and euros.


But Greek households and businesses would bear the immediate pain. Imported goods and commodities like oil would suddenly cost twice as much. Households and businesses making good on outstanding loans written in euros would see repayment double in local currency terms.


Worries about the fragmentation of Europe’s monetary union have already sapped business and consumer confidence and brought the region’s economy to a dead stop. Government austerity measures imposed on weaker economies are driving them deeper into recession.

As that recession spreads, the pain of Greece’s departure from the euro would be felt even more broadly, according to Michel Juvet, an economist at Bordier, a Swiss bank.

“At the same time we have China, which is slowing down very, very fast, we have the U.S. economy, which is losing momentum, and we have this global slowdown, “ he said. “All economies are so connected that when one country or one big zone is suffering, the others are suffering as well. This is globalization.”

Others see the crisis in starker terms.
“This is phase two of the global financial crisis," said R. Seetharaman, CEO of Doha Bank in Qatar. "That’s the reality."


This is not a game, and it is not merely a question of bringing Greek voters face to face with what an exit from the EU economic system would really be like.

It is also a question of bringing Spanish and Italian voters face to face with what will happen to them if the Greek government persists in refusing to face fiscal reality.

Further, it is a question of bringing r he governments of major economic powers face to face with what will happen to their national interests and to the global economy if the Greek government persists in refusing to face fiscal reality.

Semifinally, it becomes a question of the pressures that will now be exerted to induce or perhaps even coerce the Greek government into facing fiscal reality.

Finally, it becomes a question of whether the Greek government will attempt to adopt financially responsible policies without the support and approval of Greek voters. Thus far, there has been no indication that they would do so.



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