World wary of Greeks bearing debt

Whoever reigns at Malacanang should not to be too exuberant and too quick in claiming credit for good economic figures that in reality they have little to do with. The downside of that irresistible itch is the embarrassment when the positive data quickly fades. That seems to be the case now.

The IMF, the World Bank and many local economists have now downgraded the country’s growth prospects this year. That’s partly the fault of P-Noy and his boys for under spending during the first half but it is largely because of the economic turmoil beyond our shores. While they can do something about the first, there isn’t much anyone in this country can do about the second.

P-Noy and Finance Secretary Cesar Purisima prematurely claimed credit for the rosy economic conditions late last year. They quickly attributed the bullish stock market and positive investor sentiment to P-Noy’s clean image as a serious warrior against corruption. That’s only partly true. The other reason is that we caught the tail end of a positive global investor sentiment for emerging economies as an alternative to the stalled economies of the West.

But now, it is back to reality for most investors. The American situation still sucks pretty badly, with no less than the Federal Reserve saying this week “there are significant downside risks to the economic outlook.” But in the face of an imminent collapse of Greece with its serious repercussion for the rest of Europe, the US dollar and US Treasuries appear to be safe havens.

While emerging markets are supposed to be the bright spot in an otherwise gloomy global economic picture, investors are becoming more selective. The Financial Times reported that “emerging market equity funds last week recorded their seventh consecutive week of outflows for a cumulative drop of $17 billion, according to Emerging Portfolio Fund Research.”  

Given recent market turbulence, outflows may not be surprising, the FT observes. But, the FT also pointed out, “this is not a herd-like 2008-style stampede to traditional havens. Investors are still differentiating between regions and markets in their pullbacks, implying some confidence. Emerging market flows have been trimmed not slashed.”

That means many investors are picking the best of the emerging markets. Perhaps the large outflow from our local stock market means they don’t see us to be among the best of emerging markets that are likely to withstand the current turmoil and possibly even profit through the crisis.

Indeed, the crisis only promises to get worse. European political leaders, afraid of negative political sentiment for bailouts which a Greek debt restructuring entails, dither on doing what it should to stabilize the European economies. Because there are serious implications on European banks in the event of a Greek default or restructuring, Europe’s political leaders will eventually have to bail out Greece one way or another.  

The Greek problem is also a European banking problem. The British newspaper The Telegraph cited data from the Bank for International Settlements that shows the magnitude of the problem specially for Germany. German banks hold $22.65 billion in Greek debt. French banks hold $14.96 billion in Greek debt. Of course the largest portion of Greek’s sovereign debt is held by Greek banks at $62.8 billion. British banks hold $3.4 billion; Italian banks hold $2.35 billion; US banks hold $1.5 billion; Spanish banks hold $540 million; and Japanese banks hold $432 million.  

The ECB holds a significant amount of Greek debt. As of May,  JP Morgan (via The New York Times), estimated that the ECB owned about €40 billion in Greek bond debt after it had been buying Greek bonds in the open market for about a year. A 50 percent of write-down on Greek debt could cause €35 billion in losses to the ECB. The ECB had also lent an additional €91 billion to Greek banks. In the event of a Greek default, that debt may become worthless, and the ECB may be forced to recapitalize through taxpayer funds, from the rest of the eurozone.

Eminent economist Nouriel Roubini wrote an op/ed piece in the Financial Times early this week wherein he said Greece is stuck in a vicious cycle of insolvency, low competitiveness and even deepening depression. The only path that’s left for Greece, Roubini said, is to leave the euro. “A return to a national currency and a sharp depreciation would quickly restore growth and competitiveness as it did in Argentina and many other merging markets that abandoned their currency pegs.”

The thing is, while a Greek departure from the euro common currency may seem to be good for Greece, the effect of the default on banks holding Greek debts and the contagion effect on world economies remain traumatic. Roubini concedes as much. “The most significant problem would be capital losses for core eurozone financial institutions… Major eurozone banks and investors would also suffer large losses, but they would be manageable too --- if these institutions are properly recapitalized.”

But Roubini cites the recent experience of Iceland that show how an “orderly restructuring and reduction of foreign debts can restore debt sustainability, competitiveness and growth.” He admits that the collateral damage of a euro exit will be significant, but claims it can be contained.

Roubini concludes: ‘Like a broken marriage that requires a break-up, it is better to have rules that make separation less costly to both sides… an orderly euro exit will be hard. But watching the disorderly implosion of the Greek economy and society will be much worse.”

But leaving the euro could also turn out to be “the mother of all financial crises” for Greece according to Barry Eichengreen, a monetary historian at the University of California, Berkeley. The devaluation of the drachma against the euro, Eichengreen told The Economist, would turn any debts that remained in euros into a crippling burden. At the same time depositors, who are already edging towards the exit, would break into a headlong rush, bringing down Greece’s banking system.

The Economist also warns a Greek departure could trigger panic elsewhere, with runs on banks in Portugal and Ireland and maybe Italy and Spain. That sounds like a financial Armageddon indeed.

How does this European mess affect us? As earlier mentioned, investors are trooping back to the US dollar. A serious European crisis will cause even more investors to seek cover in the US dollar, strengthening it even more and that is not that good for the weak US economy.

A US dollar that’s too strong will discourage US exports and bring down profits of US multinationals when earnings are computed in US dollar terms. The weak US economy can stall or can weaken further causing negative sentiment to prevail, discouraging businesses from hiring and thereby keep the unemployment rate high. In response, consumers will restrict spending and emerging countries exporting to the US and Europe will suffer lower sales, leading to a global recession. That’s how the Greek thing will screw us.

How the Greeks got into this mess should be familiar stuff to Filipinos. They borrowed excessively. They have a high tax evasion rate. And the Greeks all wanted to have freebies and their politicians were eager to please. Keeping our fiscal house in order is probably the most important of the lessons to be learned.

For now, all we can do is watch with bated breath as the Greek tragedy unfolds half a world away. The world has become wary of Greeks bearing debt. The ECB and the IMF are just about the only institutions still ready to buy Greek debts out of an obligation to save the world. We were there before in 1983 when the Marcos dictatorship defaulted on our debts and screwed up the economy. We know how awful that feels.

Pre-nup agreement

Gary Mirpuri sent this one.

A couple had been married for 45 years and had raised a brood of 11 children and was blessed with 22 grandchildren.

When asked the secret for staying together all that time, the wife replies, “many years ago we made a promise to each other: the first one to pack up and leave has to take all the kids.”

Boo Chanco’s e-mail address is [email protected]. He is also on Twitter @boochanco