Submitted by Michael Cembalest of JP Morgan
As punishment for giving fire to mortals, Zeus condemns Prometheus to be chained to a rock, and to have his immortal liver eaten daily by an eagle. It brings to mind the austerity program planned for Greece. No need to go through the details; it suffices to say that it’s the most austere adjustment an OECD country has subjected itself to in 50 years in the absence of a falling currency, a rebound in GDP growth and an open economy. We created the chart below to pull together four variables we’ve discussed before, showing that Greece is effectively in No Man’s Land.
So while the total Eurozone-IMF package of EUR 110 bn was 6x larger than the one discussed just a few weeks ago, here are some glass-half-empty observations:
- Greece’s ability to absorb the lion’s share of the adjustment solely through 15%-20% declines in wages and prices is untested, and implausible. Changes to retirement ages and increased privatization make sense, but their contributions to competitiveness are very small in the short run. Note that in Greece’s prior adjustment (1989-94), the Drachma fell 50%.
- We could have included the U.S. from 1985 to 1995, when the trade-weighted dollar fell 30%, or the British Pound in 1931, which devalued by 20% after the UK abandoned the Gold Standard. Of the countries using gold as a monetary anchor in 1931, none remained a decade later. The sooner a country regained its own monetary policy, the faster it recovered.
- The bailout does little to answer questions on Ireland, Spain and Portugal; is the new “safe zone” having a line of credit that takes you out of the capital markets for 3 years? Their public sector debt burdens are not as bad as Greece, but they suffer from some of the same (or larger) corporate debt burdens and productivity gaps vs core Europe.
- History is not kind to bailouts ending contagion. The 1982 Mexico bailout did not stop the spread to Brazil, Venezuela and Argentina, and the IMF rescue package for Thailand in October 1997 did little to stop the spread to Indonesia and Korea.
- It’s hard to keep track of all the EMU pillars being discarded at once (no bailouts, changes to ECB collateral rules, Eurozone rating agency). Will ECB purchases of sovereign bonds be next? The Fed and Bank of England have done this in spades; but Europe is different. German Constitutional Court rulings in 1993 asserted powers to review ways in which European institutions might be exceeding rights conferred to them. Furthermore, the US and UK do not have to grapple with a history of monetization of government debt as a contributor to military, economic and social disaster (1923). That may be why Merkel remarked last month that "Europe is not only a community of peace, it is a community of stability".