The Full Monti (obvious, I know)

Angela Merkel has unambiguously suggested that “If the Euro fails, Europe fails” leaving no doubt in anyone’s mind, the importance of the EU and the critical danger that the Eurozone is currently in. Previous interviews from the Governor of the Bank of England, Mervyn King, may at the time have seemed incongruously grave when he emphasised how serious the current liquidity crisis was, though given the past couple of weeks’ events, he is likely feeling vindicated.

Mario Draghi, despite bold intentions announced in his first ECB meeting to cut interest rates to 1.25%, has still moved to confirm that he does not intend the ECB to act as a lender of last resort, and that pursuit of price stability is still the overwhelming aim of the ECB. Admittedly, it was always going to be difficult despite the prestigious position of President of the ECB to transform market confidence, but something may need to be done to make a seemingly “imminent” bailout of the Italian Economy to perhaps being only “unsurprising.” An IMF spokesperson has already had to quickly refute rumours that a €600 billion package had been agreed.

With Silvio Burlesconi’s recent agreement to step down amidst market pressures, bringing the tally of Governments toppled during the Euro liquidity crisis now up to an impressive 6, Mario Monti has put together a technocratic Government which will hope to improve the structure and sustainability of Government debt and bring the Economy into more favourable conditions.

Mr. Papular

It is a brutally unemotional person, who fails to admire the randomness of George Papandreou. The man who managed to single-handedly send markets into havoc. The damage done by the referendum he called (probably by accident) was limited after a quick smack  on the bottom by Angela Merkel and Nicolas Sarkozy. After a high-light reel career as Prime Minister of Greece, Pap the First stepped down despite gaining a vote of confidence, a true man of the people.

Enter Pap the Second.

PAP...dum..dum..dum..dum..dum.....AAHOOOOOO..SAVIOUR OF THE..

Saying that Lucas Papademos has a job on his hands would be an understatement. Greece’s new Interim Prime Minister, who has a background in banking, will hold the reins until elections in february, with his new Unity Government receiving the support of both the Socialist party and the Centre-right New Democracy party. He has stated that it will be his Government’s job, to target structural reform and a wider tax base. Not only this, but he has moved quickly to underline that Greece must stay in the Euro, there is no Plan B. This is a wise choice. There are those that will disagree and suggest that a fall out from the Euro would be the best move for Greece, as a the current liquidity packages limit them to stagnant growth and painful reform for the foreseeable future. However, leaving the Eurozone may be crippling for an unpredictable length of time. The problems facing countries who seek to leave the Eurozone are outlined below.

1. Political Problems.

What small amount of credibility, that the Greek economy still has would be severely undermined following a Eurozone exit. On paper, credit ratings to banks and the newly functional Greek central bank would be cut, though this would likely not matter as it would be difficult for establishments to see the economy as reliable, and international liquidity may still be a severe issue (despite having regained control of monetary policy, which would to some extent offset the loss of liquidity). Politically, the reputation of the Government would be undermined, adding tension to trade. Politicians however, are likely to be more forgiving than the Markets, and investment would plummet in the short-term with capital flight, and would be difficult to restore in the long-term.

2. Menu Costs.

Completely switching currency will bring about its own costs, and demand a lot of work. All monetary capital from coins to bank machines would need to be replaced, which would incur to the Government large costs which they can scarce afford as it stands. It would be inconvenient and public support would be hard to come by. It would not only be currency that would need to be exchanged, but financial contracts, at pre-determined rates which may or may not be accurate, which would not only be again inconvenient, but “v awks.”

3. Conversion rates.

Agreeing an accurate conversion rate would be difficult for any country but more-so for the Greeks given the volatile atmosphere surrounding their economy currently. Come in too high, and there may be an outflow of Greek savings as the value of their currency may be expected to depreciate, and confidence in whether or not people would be willing to hold an over-valued Drachma may be low. A lot of people (bankers) might profit massively at the expense of the Greeks if the conversion rate was not estimated correctly with respects to market confidence, and other major currencies. Not only this but a new currency would massively impact nominal and real values for things such as wages, and strong trade unions may barter for increased nominal wages due to the devaluation in currency, increasing labour costs, and perhaps contributing to inflation.

So, if you were to ever overhear a passer-by discussing how it would be beneficial for Greece to leave the Euro (however unlikely it is for man on street to be having an intelligent and in-depth economics debate whilst walking past you slowly enough for you to catch every word), feel free to pipe up with an “Actually Sir and/or Madame, if Greece left the Euro…”

UPDATE

Mr. Papandreou wins vote of “confidence” given power-sharing talks are held. What a guy.

Haikunomics

When Japan fell in 1990s
They were lectured by the world economists
Time for Japanese to smile
-Amol Agrawal

A depressing start

The Euro drifts along the gloomy waters of confidence, leaking profusely. Spain and Italy, desperately trying to inflate their life jackets, casting worried glances over to the bow, watching the ECB reassure a shivering, wet Greece, shouting for Portugal to fetch more warm towels.

France and Germany argue on the tiller, fighting for control of the rudder. Germany, red in the face, storms away to the starboard rail, fuming. A brief smirk spreads across the face of France, until it looked down over the prow into the ocean, noting the predators gathering below. Banks, the media and Eurosceptics all glaring expectantly.

Is the Euro a sinking ship, and are Euro-zone leaders trying to stop the sea with a bucket? Perhaps. Does that matter currently? Probably not. (Do I want to show off with my nautical knowledge? Maybe.) What matters now are the future implications of the European market bail-out deal passed last week.

A supposedly comprehensive bail-out package was put together on the 27th October by leaders of the Euro-zone to address and tackle the increasingly scary liquidity problems within European markets. However, when looked at in detail, holes appear instantly, and despite markets rallying briefly, Mr.Papandreou’s bombshell of a planned referendum (have to admire the pair on the man), despite being withdrawn still created volatility in the markets. Agreements are in place for Greek debt held by private investors, to be written down by 50%. Good news. The near prison like austerity measures being imposed on Greece as a result will ensure stagnant growth at best, and inflated cuts and shockingly high unemployment at worst. Bad news. A major European market essentially defaulted on part of its debt. Terrible news.

This in itself should be enough to demonstrate the critical situation currently. Often expectations themselves (see future post on Expectations) can act as a catalyst to the feared, undesired outcome. Firms and Banks preemptively withdrawing and relocating their capital from Greek vehicles to more secure Northern European ones, only reduce the liquidity of Greek financial institutions even further.

Higher bond yields are an indication of private investors being unwilling to hold said bonds. Greek bonds have been largely passed on due to private fears that the Greek Government would default. French Bond yields have remained low, showing a willingness from investors to carry French debt, and implying that there is still faith within the French financial infrastructure and monetary policy.

Greek debt has been restructured to make it ever so slightly sustainable in the short run, which only highlights everything that these bailouts ignore, the long run. The problems of internal devaluation aren’t addressed, nor is the 30% competitiveness gap between North Europe and South Europe. Good Luck to Mario Draghi, incoming ECB President. The most important thing currently should be ensuring the liquidity of Spain and Italy who seem to be the next dominoes in line. Special purpose vehicles such as the European Financial Stability facility have been created, though the extent to which they can restore market faith is to be seen. Interesting times ahead for the Eurozone would be an understatement.

NEXT UP: EFSF, CDS, and the PAP.