PIIGS.....

With all eyes are on Greece and the EU this week and the market taking the ‘support’ being offered with a ‘show-me-the-money’ attitude i.e. general scepticism to an attitude that while not completely similar is reminiscent of the one offered by Bear Stearns CEO Allan Schwarts and Lehman CEO Dick Fuld in the weeks and months before they went out of business: There is no problem, we are fine, it’s the market speculating against us by buying CDS on our debt, it’s unfair and someone should stop them! 

These are not exact quotes, but the kind of attitude offered by ECB governors, various EU top officials etc. Very much like Allan Schwartz and Dick Fuld they refuse to admit (at least in public) that there is a real problem. Leveraged firms as well as most countries with a borrowing requirement need to find investors to buy their debt as and when it needs to be sold, which for many countries is a very regular occurrence.

The PIIGS mnaged to hide quite well in the middle of the financial crisis, as they do not have national currencies, they did not suffer ‘runs’ on their reserves, they did not have to devalue, or defend their currency pegs with extreme interest rate hikes, which would have damaged their economies even further. Now, however, they have to face up to quite hard realities as the easy way out i.e. devaluation is not available, at least not without leaving the Euro. Years of excessive pay rises and erosion of competitiveness has to be paid for. 

A complete lack of fiscal discipline, that could easily be financed in the past, is now required on a level and a scale which is truly breathtaking. 

The only comparable situation in recent memory is Sweden in the mid-nineties. They tried to hold a peg to the Euro, defending it with o/n interest rates of 500% only to in the end give up defending the currency, completely restructure the banking system, and cut interest rates. They managed to do this better than anyone had hoped for at the time. The massive devaluation  did not lead to a lot of inflation, their big industrial manufacturing base became very competitive and it was at the beginning of a new boom in growth across the world.

The currency never recovered, growing up (in Denmark) the SEK was always in the 1.10 - 1.20 DKK range, while it has recently been as low as 0.70 it is now closer to 0.83 still a long way from it’s pre 92 highs, but that has not stopped the Swedes having a full recovery and a well functioning economy. So to all of those saying you cannot devalue yourself out of problems, I say have a look at Sweden (and probably the UK in the same period).

These options are not available to the PIIGS without leaving the Euro - the alternative is an internal ‘devaluation’ which is pay cuts across the board and probably in the 15-25% range depending on how bad the country in question's problems are and how they fare on a competitive basis. Ireland  as the only country in this group has taken steps in this direction, one of the consequences is a drop in inflation of more than 6% in January 2010 on a y//y basis.

How palatable these kind os measures will be in Greece, Spain and Portugal remains to be seen - the alternative is to leave the Euro - or face that the markets may stop funding their deficits and debt roll-over.

Greece is about 2% of EU GDP and it’s debt is a bit more than 2%, so from a strictly ‘how big a cheque do I need to write’ attitude it’s not that big - the problem when you get to Spain is much more significant and not something Germany can easily afford out of petty cash. 

The Spanish troubles are in some ways very deep - the housing market is still in deflating bubble being held from imploding by banks that refuse to take their losses on more than 1 million newly constructed houses and apartments as well as the repossessed properties they are not willing to take losses on, so keep on their books or release in sales at very high prices, but with VERY attractive financing packages, in order not to have to mark down the value of the assets. 

With unemployment north of 20% and the economy having been reliant on construction and tourism to a very high degree, it’s very difficult to see how Spain can work itself out of its current mess without draconian and unpopular measures.

In the mean time the EU leadership should own up to that this is a real problem and not dismiss it as mere market  ‘speculation’ and thinking about how they can do more to stop speculation. In their minds it’s like this: when the market buys member countries debt it’s investment when the market sells the same bonds short, or buy the CDS, then it’s speculation. Somethings never change......maybe they can get Dick Fuld to advise them on how to persuade the market that it is simply wrong......and they are right?