Thursday, September 22, 2011

A Greek 'Twist' of Global Deflation?

Left my beloved Crete yesterday to make my way up to Athens. Greece's capital is eerily quiet this morning as buses, taxis, metros, and trams are all on strike. People are striking to protest against the new austerity measures unveiled on Wednesday:

A set of austerity measures to be applied straight away were announced by the government on Wednesday evening as it tries to convince the International Monetary Fund, the European Central Bank and the European Commission, known collectively as the troika, that it is serious about meeting its fiscal targets and should receive its next loan tranche.

After a cabinet meeting lasting some seven hours, government spokesman Ilias Mossialos set out in a written statement the steps to be taken, pending Parliament’s approval in the next few days, to reduce Greece’s deficit. “These choices send the message to our partners and the markets that Greece wants and is able to fulfill its obligations, always remaining in the central core of the euro and the European Union.”

The Cabinet decided the tax-free threshold on income should drop from 8,000 to 5,000 euros. It also approved a unified pay structure for the public sector, whose details were not announced.

The government will not touch state pensions below 1,200 euros but anybody in retirement earning above that threshold will see the extra amount reduced by 20 percent. Any pensioners under 55 will have anything they earn above 1,000 euros reduced by 40 percent.

Some 30,000 public sector workers will be placed in a labor reserve by the end of the year, according to the plans announced. This means they will earn a reduced salary for a limited period before the government has the right to sack them or re-employ them.

In his statement, Mossialos also said the Cabinet had approved several structural reforms and privatizations but did not give any details. He said a new tax code would be presented to Parliament next month in a bid to rectify “inequalities and injustices that have existed for decades.”

The government hopes these measures will be enough to convince top troika officials, who will be back in Athens next week, that Greece should receive its next loan installment of 8 billion euros. Without it, the state will run out of money by the middle of October.

Speaking in Parliament before the cabinet meeting, Finance Minister Evangelos Venizelos admitted that a series of failures and the worsening recession made it necessary for the government to go on a new austerity drive.

“Do we have to take additional measures? Yes we have to take supplementary measures... because of the recession, because of the difficult task, and the weakness of the central administration have not produced the required results,” he said, while adding that the troika’s presence in Greece was necessary if the country wants to improve its public finances.

“If we did not have the supervision of the troika... we would have again unfortunately slipped off the fiscal track,” he said. “It’s not a question of intent. It’s a matter of mentality, lack of ability, management structure, methods, habits and inertia.”

The government also announced higher gas taxes and cuts in "EFAPAX," the lump-sum payment all workers get upon retiring. Meanwhile, Ekathimerini also reports that foreign officials are playing down default:

A flurry of foreign officials on Wednesday played down the prospect and the consequences of a Greek default.

The International Monetary Fund “is absolutely not discussing and will not discuss a controlled default of Greece, or an exit of the country from the euro,” the organization’s financial counselor and director of the Monetary and Capital Markets Department, Jose Vinals, told Skai TV in an interview.

“To date, European leaders have stated their strong support for European unification and this is very important. They have declared their express commitment to Greece remaining a member of the eurozone,” he said during a press briefing on the presentation of the IMF’s biannual Financial Stability Report in Washington.

“We have a very strong and close cooperation with Greece so as to ensure that the country remains on the right path and the implementation of the program continues, not just regarding the fiscal adaptation leg but also for the measures that will support growth,” Vinals said.

Separately, France’s Budget Minister Valerie Pecresse said Paris was not considering a Greek default scenario and “is doing everything to save Greece.”

German Finance Minister Wolfgang Schaeuble said Greece was the focus of speculative pressures.

“As soon as the markets are convinced that the Greek problem has been permanently solved, the risk of contagion to other countries will be significantly reduced,” he said.

Questioned as to what will happen in the event that Greece does receive a new bailout and declares default, Schaeuble said a responsible government has to take all scenarios into account “but cannot publicly consider its options for everything.”

Separately, Germany’s liberal FDP party leader Philipp Roesler toed the line of Chancellor Angela Merkel by saying, “We want Greece to stay in the eurozone, but for this to be achieved we must do everything so that it regains its competitiveness.”

The FDP’s former Economy Minister Rainer Bruederle expressed the view that Greece itself will choose the moment of a “haircut” to its debt.

For his part, Portugal’s Prime Minister Pedro Coelho warned that the consequences of a Greek default would be “catastrophic.”

As I've argued in my previous comments, a Greek default will be catastrophic for Greece, Europe and the global economy but tell that to rating agencies which Eric Reguly of the Globe and Mail aptly calls the hitmen of Europe:

What might the collective noun for credit ratings agencies be? Certainly not a pride (lions), given the agencies’ track record of untimely calls. Maybe a descent (woodpeckers). Better yet would be a murder (crows), because Italy could get killed by the ratings agencies. Italy is the new epicentre of the European debt crisis and if the country is buried under a mountain of junk-rated sovereign bonds, the euro zone is finished.

Earlier this week, Italy was downgraded by Standard & Poor’s by one notch, to single-A from single-A-plus, with a negative outlook, meaning another ratings whack job is likely. Because the agencies tend to move together, Moody’s is bound to follow with its own downgrade. On Wednesday, S&P went after the Italian banks, downgrading seven of them, including industry leaders Mediobanca and Intesa Sanpaolo.

What triggered the downgrade? And why now? Difficult questions to answer, especially since Italy was one of the few euro zone countries whose fiscal situation, if anything, seemed to be on the mend. To be sure, Italy has a gruesomely high debt, equivalent to 120 per cent of gross domestic product. But its debt has always been fat and no one in bond land seemed overly worried about it. Italy has a deep and liquid debt market – the world’s third largest – and willing buyers were always found (though Rome has had to pay much higher yields in recent auctions).

Italy is running a budget deficit, but one that has been admirably low by euro zone standards. Last year’s deficit figure was 4.6 per cent of GDP, which was half of Spain’s or Britain’s. This year the figure should land at 4 per cent, according to Deutsche Bank, and less than 2 per cent next year. With a little help from its austerity programs, Italy intends to balance the budget in 2013. In the meantime, the government is actually running a primary budget surplus (the measurement that excludes interest payments).

S&P cites falling growth as one of the main reasons for the Italian downgrade. Fair enough, but most countries in the 17-member euro zone and the wider European Union are watching their growth rates get slaughtered. The International Monetary Fund has just reduced its growth forecast for Britain to 1.1 per cent his year; it had forecast a 2-per-cent bump at the start of the year. Italy is arguably in no worse shape than Britain, yet Britain gets away with paying very low yields on its bonds, almost as low as Germany, whose debt is considered Europe’s safest.

So what’s the real reason behind the downgrade? S&P appears to have picked a subjective reason: It doesn’t have much faith in Silvio Berlusconi’s “fragile governing coalition” to make the tough decisions. Never mind that Italy last week approved a €54-billion ($74-billion) austerity program or that “fragile” could be used to describe half the governments in Europe. If general elections were held today, both German Chancellor Angela Merkel and French President Nicolas Sarkozy would be tossed onto the political scrap heap.

Of course, Mr. Berlusconi should be spending less time entertaining showgirls and more time figuring out how to protect his country from the debt crisis in Greece that threatens to sink the entire euro project. Still, the S&P downgrade seems both unwarranted and dangerous, given the economic reality.

The reality is that ratings downgrades and austerity programs are all feeding on one another to crunch growth, at best, or at worst to plunge Europe into a deep recession that could end up with busted banks and a busted common currency.

Investors drive up bond yields because they see waning growth and rising deficits and debt. The finance ministers, who are utterly obsessed with public debt ratios, launch punishing austerity programs during an era of private sector retrenchment. The economy sinks, in turn triggering more downgrades and pressure for more austerity. Fresh austerity programs arrive, hammering growth again and renewing the attention of the ratings agencies. And so on.

This vicious cycle could push Europe to the brink of destruction. Greece has already reached that point. The austerity programs demanded by the European Commission, the European Central Bank and the IMF (the “troika”) have gone from sensible to nasty to counterproductive. The Greek economy is imploding and the streets of Athens are becoming dangerous as society breaks down.

The Italians are watching in horror as the Greek economy unravels at alarming speed. They wonder whether the troika and the ratings agencies are evolving from saviours to executioners.

As I stated before, the "brilliant" economists at the troika are implementing measures which are counterproductive. Instead of focusing on growth, they are slashing wages, pensions, benefits, government jobs and increasing taxes hoping to restore "fiscal sanity." All they're doing is ensuring a Greek and European depression.

I ask again, why isn't troika going after Greece's biggest tax evaders who have parked billions offshore in Swiss and Cypriot banks and London real estate? I'll tell you exactly why: because many of the worst tax evaders are corrupt government officials who accepted millions in bribes (remember the Siemens scandal) from rich Greek corporate cronies they're now protecting. They all have a vested interest in hiding their ill gotten gains and shifting the debt burden on the poor and working poor.

And don't look for any help from the Federal Reserve whose "Operation Twist" was nothing more than just huffing and puffing. The markets showed Ben Bernanke how thoroughly dissatisfied they were following the Fed's announcement on Wednesday afternoon as stocks plunged and the 30 year US bond yield reached 2.99%, the lowest level since January 2009.

Some think this is a flight to quality as global investors, fearing systemic risk, rush into the safety of US bonds. But I also think the bond market is legitimately worried about global deflation. Participants are watching what is going on in Greece and southern Europe and think that the winds of deflation/depression will spread throughout the world.

Finally, a friend of mine sent me an interesting article on how neurosteroids may treat multiple sclerosis, giving me and others battling this disease more hope. Below, I leave you with a video comment from Tim Knight of Slope of Hope blog. Tim is one of the best technical analysts I track and he remains very bearish (a bit too bearish for me). I continue to trade risk assets, but I am concerned with the many policy blunders across the world, increasing the risk of global deflation.

Given these policy blunders, I question whether troika, rating agencies and global policymakers all need some "neurosteroids" to get their thinking straight. Indeed, stupid is as stupid duhs, but their stupidity will end up costing us all.

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