Introduction

Since 2010, I have been following the economic struggles of Greece. Back then, I noted that countries using the same currency lose an important adjustment mechanism: changes in the value of their currency. This is fine for the most productive countries. But for countries whose goods and services are more expensive, it means customers, both at home and abroad will be lost. This manifests itself in falling exports and increasing imports, resulting in an unsustainable trade balance. That is what happened to Greece. It simply ran out of Euros.

So far, the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Commission (EC) have together provided Greece with over €330 billion in bailout monies. That amounts to 180% of Greece’s annual GDP!

A little history is in order here. Back in 2010, EC/ECB and the IMF granted funds to Greece under a typical Fund stabilization program: reduce the government deficit and rein in expenditures. Table 1 shows the result of this policy: as the government deficit was drawn down, the unemployment rate rocketed to 27.5% in 2013. Clearly too much austerity!

Table 1. – Greece: Fiscal Balance and Unemployment

Source: IMF

Since 2012, Greek income per capita has fallen by 34% in real terms. A good part of the bailout monies went to private banks that had foolishly lent money to Greece after it was clear the country was on a non-sustainable economic path. The final tranche of the latest bailout monies from the EU was just released. It will disburse €8.5billion to Greece. It will help avert a fresh debt crisis in July when the next €7billon repayment of loans becomes due.

In 2012, Olivier Blanchard, the chief economist of the IMF reviewed the IMF’s earlier research findings on the unemployment effects of reducing government deficits. His conclusion: the earlier unemployment multiplier estimates of the IMF were too low. His new research suggested that a 3% fiscal consolidation would result in as much as a 1.8 percentage point increase in unemployment. But even this doubling of the unemployment multiplier does not explain the huge unemployment growth in Greece. The Greek economy was in a free fall.

To its credit, the Fund saw what was happening and gave up on its austerity program. Germany did not. In early 2012, numerous reports surfaced of growing friction between the IMF and the EU countries over the Greek program. The Fund was upset that the EU (Germany in particular) was focused almost completely on getting Greece to reduce its government deficit. The Fund insisted this one dimensional approach had failed. Clearly, the IMF was attempting to distance itself from the austerity measures imposed on the country under the insistence of the EU.

Having given up on austerity, the IMF pressed for a large number of government actions along with telling the EU further debt forgiveness would be required. Nothing has really changed since then. The key players remain the same: The Greek government, Germany as the leader of the ECB/EC bloc and the IMF. The Greek government is forced to agree with what is needed to get financial report. It then delays implementation. The EU continues to insist on austerity and no forgiveness. The IMF keeps pressing for reforms and a second round of debt forgiveness.

So we come to the latest bailout program for Greece. It includes:

  • A 10-year extension on the maturity dates of €100 billion in loans.
  • A 10-year extension on subsidized interest payments on its debt.
  • € 15 billion to boost its cash reserves.
  • In return, Greece agrees to run primary budget surpluses of 3.5 percent until 2022, and then by about 2.2 percent until 2060.
  • When account is taken on debt interest payments on debt, even at the rate of 1 percent until 2022, the overall fiscal surplus demanded jumps to around 5.3% percent of the GDP through 2022.

So Germany has gotten its way. Austerity will continue. The Greek government will fudge and further crises will ensue. So where is the IMF? It commends Greece and the EU reaching this bailout agreement but still sees another round of debt relief needed. I quote from the IMF Staff Report:

“…the debt relief recently agreed with Greece’s European partners has significantly improved debt sustainability over the medium term, but longer-term prospects remain uncertain. The extension of maturities by 10 years and other debt relief measures, combined with a large cash buffer, will secure a steady reduction in debt and gross financing needs as a percent of GDP over the medium term and this should significantly improve the prospects for Greece to sustain access to market financing over the medium term. Staff is concerned, however, that this improvement in debt indicators can only be sustained over the long run under what appear to be very ambitious assumptions about GDP growth and Greece’s ability to run large primary fiscal surpluses, suggesting that it could be difficult to sustain market access over the longer run without further debt relief. In this regard, Staff welcomes the undertaking of European partners to provide additional relief if needed, but believe that it is critically important that any such additional relief be contingent on realistic assumptions, in particular about Greece’s ability to sustain exceptionally high primary surpluses.”

The Fund has to remain on relatively good terms with its member nations. But by not a party to this latest EU-Greece agreement, it is registering a serious disagreement. Until recently, Angela Merkel’s conservatives insisted that the IMF be a party to any agreement EU/Greece bailout program. That just changed as a reflection of German anxiety about the Fund’s calls for debt relief for Athens. Eckhardt Rehberg, spokesman of the CDU/CSU parliamentary group for budgetary policy, told the Financial Times that “with the IMF insisting on large-scale debt relief for Greece — they have been talking about a three-digit number — I have a problem.”

One more quote from the IMF Staff Report:

“Greece has come a long way, but still faces many challenges…But significant crisis legacies and an unfinished reform agenda still hamper faster growth, while membership in the currency union and high primary surplus targets limit policy options….

As mentioned at the outset Greece is limited because it does not have its own currency. Without is, it can (and has) run out of Euros. Table 2 summarizes Greece’s financial dealings with the rest of the world. In the last decade, the trade deficit has come down. But overall, Greece has been saved by the huge government loans it has received. The IMF is concerned about its debt and rightly so. It stands now at about €320 billion or about 175% of its GDP.

Table 2. – Greece: International Balances

Source: Bank of Greece

But Germany and other countries who foolishly lent Greece monies do not want any defaults. Are they not engaged in wishful thinking?

  • Where are the funds to pay off these debts going to come from?
  • What happens when the European Central Bank stops buying up Greek bonds?

Consider what Greece would have to be paying in interest on its debt at market rates. 5% of €320 billion works out to €16 billion annually. And when you add to that paying off its maturing debt…. The Fund is right to be concerned. The Europeans are “kicking the can down the street.” And Greece is supposed to run a surplus of 3%+ indefinitely? This “crisis” has just been extended.

Investment Implications

Europe continues to be a very uncertain place:

  • The immigration crisis is causing a major political realignment.
  • Britain wants to exit the European Union. But it is far from certain that it can work out a satisfactory deal with the Union.
  • Greece and the other “weak sisters” in the Eurozone will continue to have problems.