Wednesday, May 30, 2012

Pain in Spain and new elections in Greece: Investors are in a panic

Doubling up on failed policies in the EU is leading to the specter of massive and costly defaults of  hapless Eurozone members. As EU policy makers keep increasing the cost of abandoning the Euro to prevent Eurozone governments from willingly “misbehaving” and abandoning the euro, they ignore the accelerating amount of damage to the country and its creditors if things fail and social turmoil leads to this outcome. This is really spooking the markets and investors, who are withdrawing from the Eurozone.

Greece will inevitably be forced back to its national currency. The Greek public debt will have to be restructured with deep haircuts. The PSI+ is a dead letter. The really big issue will be the EU public debt to Greece, which needs to be written off in large percentages and the political fall-out thereafter in the lender countries for these “pretend and extend” follies.

In effect, the Euro is a greater Deutschemark zone. It never met the Mundell optimal conditions for a proper currency zone. The Germans have used this to promote a mercantilist export machine based on internal wage restraint and financial repression. This generates for them nice surpluses whereas the other hapless EZ members face growing deficits. The deficit countries have been pushed into massive increase of public debt to cover the growing trade balance deficits to avoid massive unemployment. EU policy makers and political elite knew that the system was defective, but they counted on using any crisis to promote forced political integration. They did not count on how difficult this would be under circumstances of deep economic recession and political stress.

The Euro works as a gold standard where the brunt of adjustment falls on the deficit countries. The only means to readjust is mass wage, salary and pension cuts, so this causes enormous social unrest from the severe deflation. The deflation makes the debt burden significantly worse, leading to spectacular drops in GDP and growing risk of huge and unmanageable debt defaults. Politically, the elite in the EU and Greece have lost legitimacy.

So in Greece, there is fragmentation of the political system. The whole basis of the 3rd Greek Republic is in question. There is a vacuum of political leadership. Greece is basically a poor country, living on a borrowed currency under colonial status within the EU. The two major contenders in this election are the “conservative” New Democracy party calling for Greece to “stay” in the Eurozone at any price and the Leftist SYRIZA declaring the IMF/ EZ/ ECB memorandum signed earlier this year a dead letter open for renegotiation. ND is basically living in the past, hoping to put “Humpty-Dumpty” together again with the EU and Eurozone. By chasing the impossible, refusing to admit insolvency and the impossibility of remaining in the Euro economic strait jacket; they are courting the worst possible outcome of disorderly default.

SYRIZA is the poster child of the last 30 years in Greece on Eurozone dependency as a welfare ward. They have discovered debtor’s leverage and challenge the EZ to continue the transfer money without the Memorandum austerity conditions. This puts the dilemma back on the EZ. If the EZ elite want Greece to stay in the Eurozone, effectively they have to convert their bailout loans to transfer money, something that the IMF has already been timidly suggesting in their latest debt sustainability reports. SYRIZA is forcing the issue that ND wants to avoid in direct confrontation with the EZ Core.

Neither party has any plan for Greece to stand on its own two feet, develop a proper productive base, etc. Greece is like a third or fourth generation family living on welfare entitlements. The Greek people are very ill prepared for the chaos that is confronting them.

The contagion issue of Greece leaving the Eurozone is probably overblown for political consumption but it difficult to see how the EU has enough resources to hold the Eurozone together with all the debt pyramiding to cover up the trade imbalances, especially falling into ever deeper recession. The current turmoil in Spain regarding Bankia and the failed attempt of the Spanish government to force the ECB to undertake its recapitalization to avoid losing sovereignty in another EU bailout program is illustrative of the challenges.

The EU elite suffer from a siege mentality. They have staked their political careers on the Euro project. If it fails, they are in disgrace and discredit and this reflected in an increasingly angry and desperate electorate whenever national elections are held. This highly problematic currency zone is failing and any attempt to manage the risks and minimize the damages falls on deaf ears in Brussels.

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