Regardless of how the Euro Zone finance members really think about the economic and financial matters of its 17 members, the word from the finance ministers assembled in Davos was inordinately optimistic. The cause for that optimism is difficult to understand and might lead one to wonder if this is simply another effort to stabilize the economies whose demise has now spread to the heart of Europe.
The Euro Zone’s well-orchestrated damage control went in to a full court press, including a two-part interview with CNBC by former ECB President Jean-Claude Trichet. In the first leg of the interview, Trichet touched upon general observations saying the Euro Zone Crisis is a serious and global problem. Trichet added that Euro Zone finance ministers were operating on a round the clock crisis mode.
The former ECB president described the current situation as progressive, but that market conditions inspired no confidence. On a day when Spain, Portugal and Ireland came under closer scrutiny, the euro remarkably crossed the $1.32 barrier settling at its highest value since early December. The concept of a global crisis serves the Euro Zone well because it infers that external forces should enter the fray.
Trichet indicated that the progress made in the last 5 months was an indication of how the Euro Zone members are committed to reversing the crisis. However, under questioning, Trichet did say the investors in Greece would take a significant hit but admitted that he did not believe losses would be incurred by the ECB.
Like every release from the region, the statements from Davos were muddled. An unidentified finance minister said that the deal with Greece’s private investors was ready to proceed. The losses suffered by these investors will be painful. European Economic and Monetary Affairs Commissioner Olli Rehn said he expected the deal to close before February and probably over the weekend.
The response was swift. Italian 6-moth bonds fell by 2 percent to the lowest level since May 2011. Germany’s auction also offered lower yields.
A default by Greece seems unlikely, but there will be a significant shortfall of 12 -15 billion euros to reach the mandated goal of 120 percent debt to GDP. This is the level that the IMF has designated as sustainable. The current ration is 160 percent of GDP.
In a later segment of the CNBC, Rehn was adamant that Greece would not enter into an unstructured default. When asked what effect the default of Greece would mean, Rehn did everything possible to avoid the “C” word, contagion. It is clear that the fear of massive default is what is prompting such a concentrated effort.
One of the features of a renewed optimism is an expansion of the income stream. German finance minister, Wolfgang Schauble, supports the new transaction tax on all financial transactions. Currently every other type of transaction has a use tax.
Virtually every type of austerity cut has been discussed with Greece, but as happens often in the Euro Zone, the austerity cuts have been resisted by the Greek populace. One of the purposes of this summit is to identify the promised cuts and address their implementation as swiftly as possible.
While all eyes have been focused on the resolution of the private investors, these promised cuts have slid off the table. These are precisely the administrative commitments that seem to falter when they are applied to the real life environment.
One of the most important examples of this laxness is Greece’s unwillingness to address the reform of the supplementary pension program. This has already been met with numerous demonstrations but has been promised as a condition of approved austerity cuts.
Other important promises by Greece that have not been implemented include:
- Spending cuts on defense.
- Spending cuts on health provisions.
- Elimination of superfluous governmental agencies.
- Improved tax collection initiatives.
- Trim the number of workers leaving the workforce to 1 in every five persons compared to the 5 of 5 current support plan.
- Open job markets for professions such a lawyers and pharmacists that have been sealed for years.
- The Bank of Greece is charged to complete an assessment of the country’s banking capital shortfalls.
- Greece is charged to improve wage flexibility and open service sectors that have been heavily regulated and thus are non-competitive.
Good luck with that! Greece has only agreed to negotiate some of those requirements. To supply funding to Greece without strict compliance is the equivalent of kicking the can down the road.
Originally these conditions were contingencies for receiving any further funding. The IMF is firm in its position that Greece must enact these conditions. The IMF, ECB and EU are all firm that Greece must pass the 2012 budget that includes these actions.
Greece has agreed in principle but has not enacted their austerity programs. With private investors taking painful losses, Greece somehow seems to think that life can go on as before the crisis. It is this mindset that is the cause for alarm. Neither private nor public lenders will extend any further funding if these terms are not met.
Geithner Urges Caution
U.S. Secretary of the Treasury, Timothy Geithner, has delivered his thoughts about the Greek and Euro Zone Crisis. He cautioned investors that extraordinary austerity cuts would be reflected in GDP.
Geithner urged the Euro Zone members to solidify the EFSF. Geithner believes that without bigger commitments to the European Financial Stability Facility, the crisis will worsen because the funds for future bailouts will be depleted. In his mind, Greece is only one piece in a 17-piece puzzle.
The U.S. does not standalone on this stage. China and other major economies have strongly suggested that the Euro Zone needs to come up with their own funding to stabilize the market. Both China and the U.S. praised the ECB for its low interest loan program.
Spain and Portugal
Spain’s plans to avoid the need for billions of euro funds appear to be crumbling at this moment. Reports from the country’s banks indicate that the administration has significantly underestimated the capital needs of the nation’s banks. Since the outset of the global recession, Spanish banks are carrying billions of euros of unsalable assets and billions more of impaired loans.
Spain has joined Greece as another country in need of outside cash infusions. The fact is that nobody has an accurate estimate of the amount but it is substantial. The government has previously asked its banks to come up with about $66 billion to stabilize unstable financial institutions.
The Bank of Spain estimates that Spanish foreclosures account for about 175 billion euros. Of this amount only about 58 billion has been accepted as losses. These figures do not include losses incurred by local lenders.
Spain’s Deposit Guarantee Fund has already received some additional funds after being depleted of its 5.2 billion euros when the CAM savings bank was rescued. Spain is preparing to approach the EFSF for cash infusions. This is precisely the contagion that the Euro Zone finance ministers have feared.
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