A version of this post appeared yesterday at Credit Writedowns.
I am running a poll on whether Greece will default. Please click here to vote. And feel free to comment on why you voted as you did.
German Chancellor Angela Merkel is feeling pressure to force German banks to take a haircut on Greek debt by both her own party and opposition leaders (like Frank-Walter Steinmeier, the former Vice Chancellor and now head of the opposition in the Bundestag). This is the first public indication that German politicians recognize that a Greek default would negatively impact the capital base of German domestic institutions which hold large amounts of Greek sovereign debt.
So, now the rhetoric is shifting away from one purely of austerity for Greece in return for (the now larger) aid to one in which Greece undergoes a voluntary restructuring. Yves’ most recent post on this topic tells you that. On Friday, in a post based on Marshall’s BNN interview, I mentioned three scenarios for Greece at this juncture.
- In scenario one, you eject Greece from the Eurozone, they devalue their currency and, after a turbulent period, they are on the road to recovery.
- Outcome number two is to depreciate the Euro, of course. The Euro is dropping as we speak. But, I am talking about a more serious decline. As I recall, the Euro dipped to as low as 83 cents during Robert Rubin’s strong dollar policy days. If the EU structures the bailout in the right way (fully backstops the period of increasing debt to to GDP) and floods each country with liquidity (aka prints money), you are sure to get this kind of outcome. Everyone gets a massive boost to competitiveness. Problem solved.
- Neither of these scenarios is particularly palatable as they are likely to increase already mounting trade friction. The other Edward mentions the only other viable alternative: a restructuring or default.
So, where there has been a lot of political posturing around scenario number one (or its analogue in Germany and a few core Europe countries leaving the euro), there has been little public discussion from policy makers about scenarios two and three. In the link in the last bullet above, Edward Hugh puts it in plain English.
At the same time, some sort of Greek default is now no longer simply a theoretical possibility among many others, indeed talk of the inevitability of some form of debt restructuring (albeit voluntary) grows with every passing day. Erik Nielsen European Economist with Goldman Sachs said this week he is expecting Greece to offer some sort of “voluntary debt-restructuring” to creditors over coming months, while JP Morgan issued a research note saying that while such restructuring may not be imminent, the move would make sense given that Greece could be seen as “the sovereign analogue of a ‘bad’ company with a bad capital structure”.
Restructuring is simply a polite word for default, with the difference that it is normally carried out by agreement. The most likely form of restructuring in the present context would be debt rescheduling, whereby short and medium-term debt is converted into a long-term version, as happened with the so-called “Brady bonds” devised by the US Treasury to resolve the debt difficulties of a number of Latin American countries in the late 1980s.
Two weeks ago, we were considering the options including True Fiscal Austerity (see Greece And The Potential Upside In An IMF Rescue). Yet, while Marc Chandler mentions raising the pension age to 67 without exception as part of a True Fiscal Austerity solution, few are talking about True Fiscal Austerity as a solution anymore. It’s now either a default or restructuring within the euro-zone or a break-up of the euro-zone (and default or currency devaluation). This is a signal that things have deteriorated significantly. The worry now must be contagion inside the euro-zone and within the banking sector.