Greece: Something will give, austerity or growth or both
The results are in from the poll on Greek sovereign bond default. To the question of "Will Greece default?" a plurality said "Yes, but they will stay in the euro-zone after a managed restructuring." Another 26% answered that Greece will default in a messy and uncontrolled way. Only 16% believed that Greece would be able to see through its austerity measures and avoid default. The results are below.
What is clear from the Greek situation is that Greece faces a tough battle to reign in its high budget deficit. The best example of what is in store comes via the note from Win Thin which I highlighted yesterday. He pointed to only two cases where a primary budget deficit has been reduced as much as Greece would have to reduce its budget deficit. The fact that they can do so over 5 years (2010-2014) instead of three (2010-2012) is helpful. But, they have only enough money to last them through one and a half years of deficits as most prognosticators put the net new borrowing at 65-80 billion euros for this coming year and have received 110 billion euros.
I voted for default (and restructuring). I don’t think the Greeks can make it and for one good reason: the economy. First and foremost, the European economy may be improving but it is still weak. As Win Thin pointed out, a large reduction of the primary deficit requires a robust economic outlook. However, the austerity measures that all European nations are taking to reign in their budget deficits reduces consumer demand across the Eurozone. That makes for a weak economic outlook in the Eurozone. I laid this out in March regarding the situation in Spain, when I said:
If Spain is forced to run austerity measures as seems likely, in stage two, this shifts their government deficit markedly down. Given Spain’s poor labour competitiveness, sticky wage prices and inability to depreciate the currency, all of the adjustment falls onto the private sector in the form of reduced net savings (which could include larger debt burdens). But, the thing to realize is that total GDP in Spain is lower in this scenario, which means total imports are lower, which means Germany’s total export volume is lower. This is a deflationary scenario.
I know for a fact that Germany and Austria (another net exporter) are already cutting back their deficits, Austria via higher taxes. We see Ireland, Spain, Greece and Portugal doing ‘austerity’ measures to rein in government deficits too. Meanwhile, having seen the financial sector balances chart, you know that austerity means higher debt burdens in those countries, but also lower exports in Germany, which is also cutting back its own Government spending. So, austerity not only kills the Spanish economy and makes it prone to a debt deflation scenario, it also hurts the German export economy while they themselves are cutting back on government deficits.
What you have here is a perfect recipe for a double dip and a serious economic nightmare. Unless Germany can get its consumers to start spending more, the Eurozone is going to double dip.
So, there is no excess consumer demand coming from within the Eurozone. And given what I have detailed in two recent posts (see here and here), the excess consumer demand in the US is unsustainable. The only way that Greece could get around this problem is through exports, which requires currency depreciation or consumer exports to the BRICs which are actually growing at a good clip.
We know that US President Obama wants to export his way out of weakness. A competitive currency depreciation by the Eurozone would not sit well with US policymakers even if the Europeans could pull it off. Another potential avenue out of this problem is via an increase in tax compliance by the wealthy. If the government can raise more tax revenue without hurting the domestic economy, this could be Greece’s saving grace.
I say ‘hats off’ to the Europeans for executing their Hail Mary pass. They have put something workable together and that has put a floor under Eurozone sovereign debt yields. The ECB has even gone along for the ride. The European Central Bank has decided to junk up its balance sheet with subprime sovereign debt collateral much as the Fed has done with US mortgage subprime debt.
Maybe we will see a masterful tax-raising plan that doesn’t crimp growth or Eurozone consumer demand firing on all cylinders. We can always hope. But, the bail out is really just the blind hope kicking the can down the road. It simply is not credible to expect austerity and robust growth at the same time or even one after the next. Something has to give, either austerity or growth or both.