Starbucks engulfed in flames after Greek workers and youth went out in rebellion opposing another round of austerity measures imposed by international finance capital. Parliament acquiesced to the imposition of draconian cuts., a photo by Pan-African News Wire File Photos on Flickr.
A Greek default will not inevitably lead to a world economic crisis
GREEK default, which appears inevitable, will not necessarily cause the break-up of the euro or plunge the world economy into crisis.
However, Europe will continue to cast a long shadow over the global economy and, as a result, Australia's outlook as well, as recession in the most heavily indebted countries makes their problems worse.
It was plain in speeches from the Reserve Bank last week that the slow burn of the mid-sized European countries, rather than the sudden immolation of Greece, is its biggest concern.
The year has started with far greater optimism as a result of the European Central Bank's massive support for the banks, notwithstanding the agonising Greek drama that is staggering towards a tragic conclusion.
Reserve Bank assistant governor Guy Debelle cautioned last week that there had been bursts of optimism about Europe before they had been dashed.
...However, he argued in his speech on the European crisis that the ECB's intervention, offering the banks as much three-year funding as they wanted at 1 per cent, had removed any doubts about the ability of the banks to fund themselves.
Debelle said there had been serious concerns about whether banks would be able to roll over debts worth more than E250 billion ($306bn) in the first quarter of this year. Many of these debts were government-guaranteed issues that were contracted during the global financial crisis.
The ECB advanced the banks just under E500bn in December and is about to embark on a second wave of liquidity support, for potentially even more.
Besides removing the risk that banks would not be able to fund themselves, the ECB's intervention was a back-door method of supporting the more vulnerable European states.
Barred by treaty from buying sovereign bonds directly from member countries, the ECB took a circuitous route. By giving the banks as much money as they wanted at 1 per cent, it enabled them to buy the sovereign bonds in their own names and make an immediate profit. As a result, bond yields around Europe came down, with Italy, which was a particular worry, seeing its sovereign bond yields fall from more than 7 per cent to about 5.5 per cent.
However, it has not made much difference to Greece, as no one is buying its bonds. Greece has what looks like a zero hour approaching, as it must repay E14.4bn to private lenders by March 20 or confront a disorderly default. It does not have the money and is waiting on a E130bn bailout from its euro brethren, having agreed to cut public servants and raise taxes.
With classic European dithering, it is far from clear whether they will sign up to a deal that throws good money after bad.
Meetings for today were postponed, but talks are continuing and some sort of half measure to tide Greece over remains possible.
But the deal, which is intended to be accompanied by a E100bn writedown of Greece's private debts, would still leave it owing about E350bn, or some 150 per cent of its diminishing GDP. The writedown would likely be classified as a default by global banks and trigger the credit-default swap insurance, spreading liability far and wide.
However, as, a managed event, it would still leave lenders with some of their exposure intact.
Most private banks have already written down the vast majority of their Greek debt, so default, of itself, should not trigger a banking crisis.
An analysis by Citigroup chief economist Willem Buiter says the writedowns will not be enough and Greece will not be able to support debts of 120 per cent of GDP, which the package is designed to achieve by 2020.
He expects this package to be followed by several more, which will result in lenders losing more than 85 per cent of their funds. Buiter puts the chance of Greece then leaving the eurozone at 50-50. But the practical obstacles are enormous. Greece's payments system is hard-wired to the euro so every international transaction would unravel. Greek banks would face a run.
The other members of the eurozone do not have the power to expel Greece, although they could choose to leave themselves. But belief in the European currency project still runs deep.
Greece is increasingly seen as a special case. Although Portugal is sometimes bracketed with it, it has also benefited from the ECB's support for the banks and its bond yields have come down. Portugal also has a much more robust export industry.
The Reserve Bank believes the biggest threat this year is that European nations get caught in a downward spiral of budget cuts and shrinking economies.
Spain, with debts in excess of E1 trillion, is the biggest worry. Last year, it cut spending and raised taxes by about E300bn in a bid to get the deficit down from about 8.5 per cent to 6 per cent. But shrinking revenue as the budget cuts hit business activity mean that the budget deficit will exceed 8 per cent, possibly rising above 9 per cent. More spending cuts are being ordered, but with unemployment in excess of 20 per cent, the result may be no better.
The Reserve Bank's newly appointed deputy governor, Philip Lowe, says although there are examples in history where budget tightening has been accompanied by strong GDP growth, it has generally occurred when there is strong growth in trading partners, an ability to ease monetary policy and a fall in the exchange rate, none of which applies to Europe.
"There is therefore a material risk that fiscal consolidation weakens growth in the short run, which leads to more fiscal consolidation in order to meet previously announced targets and, in turn, yet weaker growth," he says.
The result, of course, is that debt-to-GDP ratios rise and the sovereign debt problem becomes ever more intractable.
Debelle says the only thing that is certain is that uncertainty over Europe will persist for some time.