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April 30, 2010

Greece - The End of the Beginning

"How did you go bankrupt?" "Two ways, gradually and then suddenly."The Sun Also Rises - Ernest Hemingway

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”Sir Winston Churchill - Speech in November 1942

On the morning of 29 May 1453, the small postern called Kerkoporta was left open by accident or treason, allowing the first fifty or so Ottoman troops to enter the city of Constantinople. The Ottoman-Turks raised their banner atop the Inner Wall and opened fire on the Greek defenders of the peribolos below. This spread panic, beginning the rout of the defenders and leading to the fall of the city.Doukas (c. 1400 – 1462)

Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence - especially in cases in which large short-term debts need to be rolled over continuously - is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits.This Time is Different - Carmen M. Reinhart and Kenneth Rogoff

Introduction - Greece is the Word

If you had read “This Time is Different: Eight Centuries of Financial Folly” by Reinhart & Rogoff, none of the current alarm over Greece’s debt situation would come as any surprise. Indeed the book shows that Greece has been in default roughly one out of every two years since it first gained independence in the nineteenth century. However, as the quote above illustrates, it is never knowable in advance at what exact moment the tipping point is reached.

Today, the government of Greece is burdened with approximately €275 billion of debt, equating to 115% of GDP, are running a nearly 14% budget deficit for 2009, [Eurostat, April 2010] and S&P has downgraded their debt to BB+/B - junk status! Up until March, the world bond markets had taken a remarkably sanguine view of this situation. In January, the Greeks sold €8 billion worth of bonds at a rather high (historically) 6.25%, while there was demand for €25 billion. But shortly afterward, the situation deteriorated rapidly.

On April 22nd, Eurostat, the EU statistics agency, revised Greece’s fiscal deficit upwards by a full percentage point and cast doubt on the quality of data provided by the Hellenic Republic. This was the straw that broke the

camels back. Greek 5-year CDS promptly jumped to a record high of 505Bps, and the difference in Greek vs. German 10-year government bond yields rose to 520Bps, near a 12-year high. Greece’s hand was forced, and on Friday April 23rd, they succumbed to the inevitable, and Prime Minister Papandreou formally requested the activation of the EU/IMF bailout mechanism.

EUR/USD 1.3297EUR/JPY 124.76EUR/CHF 1.4327EUR/GBP 0.8706EUR/NOK 7.8505GBP/USD 1.5270USD/JPY 93.860

Currencies

Bonds 10YR

Gold (Troy Ounce)

Oil (Barrel)

Equities

US 3.65%Germany 3.01%Japan 1.29%UK 3.85%Greece 8.94%

USD $1180EUR €890

ICE Brent $87.44NYMEX WTI $86.15

S&P 500 1187DAX 6136FTSE 100 5553NIKKEI 11057 SHANGHAI 2870

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April 30, 2010

Greece - The End of the Beginning

Bailout Uncertainty

The EU/IMF bailout mechanism however, has, at time of writing, yet to be finalised. The uncertainty over it’s terms and likely implementation have meant the calm that the activation was meant to bring has been lost. The bond markets have shown no mercy. Today the 2-year Greek bond yields approximately 13%, the 5-year CDS in close to 750, and the spread between the German 10-year is close to 6.5%. The market is reflecting the tremendous difficulties inherent in such an unprecedented action.

First, it involves almost impossible coordination among all the major powers within the EU & the IMF. It requires the unanimous pre-approval of all the EU heads of state & some parliaments. It involves the European Commission, the European Central Bank and the International Monetary Fund (IMF) all visiting Greece to perform financial assessments, and coming to agreement. Germany is the main stumbling bloc in this process, with the majority of German politicians & the public dead set against the bailout, and even if this obstacle is overcome, there is a legal case waiting to be lodged before the German Federal Constitutional Court. Interestingly, as Felix Salmon of Reuters notes, it is not strictly in Germany’s interest to bail any profligate member out. This must be playing in the back of Angela Merkel’s mind daily.

Second, even if overall agreement can be reached, and as of time of writing this looks likely, will Greece be able to agree to and enforce the austerity measures necessary to receive the aid? Today the Greek government have in principle agreed to a €24 billion austerity package. Amazingly though, even at this late hour it seems Greek negotiators were still trying to delay timetables and dilute some public sector reforms. The IMF had little sympathy. The bigger concern now of course is how the Greek public will react. They are known to strike regularly and en masse, sometimes even riot, but will this lead to serious civil unrest? And how will the government tackle the crucial problem of tax evasion? There are many issues here left unresolved.

Finally, the tenure, size and structure of the overall aid package is in doubt. The Economist maintains that a minimum of €75 billion over 3 years is needed. But in fact, if this is to be a 3-year package, gross Greek funding requirements through to the end of 2012 run to €110 billion, and almost three-quarters of that is to cover redemptions. There are well founded rumors, though nothing concrete, that the head of the IMF, Dominique Strauss Kahn has orchestrated a €120 billion package in joint cooperation with the EU. But the loans are not nearly enough, the structure is also important. If EU & IMF loans, as is usual, take priority over all other bondholders, then private money would have no incentive to lend, stymieing a crucial aim of the overall package - to get the bond markets to reopen for Greece. However, in a highly unorthodox move, the IMF loan appears to be junior to existing debt. This would be an interesting departure from historical norms. There was talk of bondholders taking loses, but that has now been swept aside. We will of course know all the details very shortly.

It is crucial to realise that the market is now expecting a minimum of €100 billion over 3 years. The package announced must fulfill these expectations. It also must be realised that by making the loans contingent on Greece meeting budget cut targets, the EU/IMF run the risk of undermining confidence in the whole package. The market fears most of all Greece’s ability to change, and essentially has no faith in getting its money back under the current regime. At this point only unconditional support will do, but that is unacceptable to Germany. It’s no wonder that the process so far has been disorganised, rancorous & completely reactive.

A Restructuring (or default) is Inevitable

So, where to from here? It will be obvious in a moment, that some form of restructuring of Greek debt is inevitable in the long run. But in the short run, there are really only 2 scenarios that I see as likely;

The bailout is agreed - this buys time, approx 2-3 years max until a managed default can be arranged.The bailout falters - Greece goes straight to an unmanaged default.

But first, why is a restructuring inevitable in the long run? Martin Feldstein, a professor of economics at Harvard, former Chairman of President Ronald Reagan's Council of Economic Advisors and President of the National Bureau for Economic Research, puts it best;

“There simply is no way around the arithmetic implied by the scale of deficit reduction and the accompanying economic decline: Greece’s default on its debt is inevitable.In the end, Greece, the eurozone’s other members, and Greece’s creditors will have to accept that the country is insolvent and cannot service its existing debt. At that point, Greece will default.”

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Greece - The End of the Beginning

A Restructuring (or default) is Inevitable cont’d

For some more quantitative analysis, we turn to Wolfgang Münchau, writing in the FT on April 18th;

“The bail-out prevents a default this year, but makes no difference whatsoever to the likelihood of a subsequent default. Just do the maths: Greece has a debt-to-gross domestic product ratio of 125 per cent. [Eurostat figure is 115%] Greece needs to raise around €50bn ($68bn, £44bn) in finance for each of the next five years to roll over existing debt and pay interest. That adds up to approximately €250bn, or about 100 per cent of Greek annual GDP.

But even if the Greek government were to present a credible long-term stability plan, the risk of default would remain high. This means that some form of debt restructuring is unavoidable. Restructuring is a form of default, except that it is by agreement. It could imply a haircut – an agreed reduction in the value of the outstanding cashflows for bond holders. The Brady bonds of the late 1980s, named after Nicholas Brady, a former US Treasury secretary, worked on a similar principle. An alternative to restructuring would be a debt rescheduling, whereby short and medium-term debt is converted into long-term debt. This would push the significant debt rollover costs to well beyond the adjustment period.

The best thing you can say about the rescue package is that it buys time to negotiate an orderly default. Restructuring and rescheduling is probably the only chance for both Greece and its bondholders to come out of this mess still standing.”

Indeed the market is already pricing some from of restructuring in. Prices for Greek debt will only stabilise when clarity is brought to the fore. Despite assurances from the various authorities that “restructuring is off the table”, in the long run, it is unavoidable, and the market knows this. Interestingly, according to Erik F. Nielsen, chief European economist at Goldman Sachs;

“PM Papandreou is planning to appoint a central coordinator for the government’s interactions with the IMF and the European counterparties. According to the FT, highly respected outgoing ECB vice-president Papademos has turned down the offer of the post, which – if confirmed - makes me wonder whether Papademos sees what I see, namely an overwhelming probability that we are indeed heading towards a debt restructuring, and being in the middle of this mess is just not the way he wants to end his fine career.”

Back to the Future

Now that it’s understood that some form of default is assured, onwards to my 2 scenarios. As I said earlier, even is the bailout is agreed & implemented, this only buys 2-3 years max. What happens then? In the first scenario the politicians and the various Greek debt holders come to the realisation that there is simply too much debt, that full repayment is an impossible task, no matter what the timeline, and they mutually agree to restructure. In scenario 2 however, the Greek public are unwilling to make the sacrifices necessary, and mobilise against the regime, leading to a governmental collapse and economic chaos. This has a strong precedent in Argentina and numerous other developing countries.

Scenario 1 - Managed Default

• Other PIIGS and possibly Austria immediately see their cost of funding rise, and stay high.• Market seeks credible & concrete reassurance from Eurozone core on other PIIGS debt but

does not get it.• Cascade of managed defaults across the PIIGS as debt is restructured.• Greece stays with EUR while austerity measures are acted out, with funding from IMF &

EU.• Steady decline of EUR vs. every other major currency.• Bunds widen (prices fall) as Germany seen to be “on the hook” for all bailouts.• Banks across Eurozone need further bailouts.• Inflation begins to hit Eurozone in earnest.• Current Eurozone stays intact up to & until austerity measures become too severe causing a

PIIGS member to leave. (Argentina Scenario - see end of piece)

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Greece - The End of the Beginning

Back to the Furture cont’d

Scenario 2 - Unmanaged Default

• Greek population suffer immediate unavoidable austerity.• Popular unrest/political chaos/creditor confrontation culminates in Greece leaving the Euro.

(Argentina Scenario)• Other PIIGS members and possibly Austria immediately have major funding difficulties. • Other weak EUR members forced to declare bankruptcy and leave the EUR soon after,

devalue & become more competitive. (Argentina Scenario)• EUR weakens considerably against every major currency until only the core members are

left, after which it strengthens.• Bunds tighten and stay risk free.• Banks in Germany, Switzerland & France need further bailouts, banks in PIIGS see major

bank runs, flight to quality benefits Deutsche Bank, HSBC, and other major international players.

• Inflation begins to hit Eurozone in earnest, but is taken back under control when weaker members are removed

• Weaker member suffer hyperinflation. (Argentina Scenario)

Let’s now discuss the various aspects of these two scenarios.

Contagion - Is it assured?

Are Greece’s troubles already affecting other PIIGS members, and if so, why?

Contagion from the Greek debacle is clearly evident already in the heightened bond yields and CDS levels associated with the various PIIGS. Jürgen Stark, ECB Board Member, recently spoke openly

on everyone’s primary fear;

"We may already have entered into the next phase of the crisis: a sovereign debt crisis following on the financial and economic crisis."

But could this situation really morph into something so serious? And how bad would it be upon either a managed or unmanaged default by Greece?

Let’s start with the PIIGS current known funding needs. The total, defined as the sum of debt maturities and budget deficits

over the next 3 years amounts to $2 trillion. Total PIIGS funding needs in 2010 alone amount to $600 billion. (A reminder - total IMF bail out capacity is around $700 billion) See table below;

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Contagion - Is it assured? cont’d

Italy has already had something of a hiccup at a bond auction. Last Tuesday the country sold €9.5bn of six-month bills. But crucially, they received only €9.78bn in bids for the bonds, indicating a bid-to-cover ratio of just 1.02. Below 1 is considered a failed auction. What’s more, the average yield was 0.814 per cent, far more than analysts had expected and above the 0.567 per cent yield on offer at an auction of the same type of bonds last month. It is also interesting to note that today Ireland’s NTMA decided not to go to the debt markets in May, citing adverse conditions.

As Erik F. Nielsen, chief European economist at Goldman Sachs, notes;

“And the domino theory? In the short term, anybody with financing requirements can be hit by lack of liquidity, so its not inconceivable at all that the IMF will need to get ready for another Euro-zone case in coming months.”

Now let’s look at the PIIGS’ economies;

Clearly we can see that although some may have acceptable Debt/GDP ratios, the main issues here are structural. The PIIGS are woefully uncompetitive vis a vis Germany, are running major budget deficits (excluding Italy) and are all saddled with high unemployment. Their ability to grow out of this crisis will be limited by austerity measures demanded by the market to cut deficit levels. This is a catch-22 scenario. There are only 3 ways to reduce debt burdens; inflation, economic growth, or default. With inflation a non starter and growth highly unlikely, markets are slowly drifting towards default as the most likely solution.

So even before any default from Greece, we can see why there would be apprehension towards holding the PIIGS debt. But the real spark to set off the contagion, is what Mohamed El-Erian, CEO and co-CIO of PIMCO calls a fundamental re-evaluation of risk;

“It appears that the catalyst for the recent down leg in the prices of Greek instruments is selling by long-standing holders. This is consistent with the April 7th observation that, counter-intuitively for some, persistently high and volatile government spreads would push some investors to sell, rather than buy/hold.

There are still too many investors out there with industrial country government holdings (such as Greece) that they deemed (wrongly) to be interest rate risk exposure rather than credit risk exposure. With excessively large risk-adjusted holdings, the continued volatility of sovereign debt prices will force these investors to sell, further fueling the contagion risk associated with the Greek debt debacle.”

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Greece - The End of the Beginning

Contagion - Is it assured? cont’d

So then, what metrics should we look out for to see if contagion is afoot? Paul Krugman, NYT columnist and Nobel prize winning economist wonders;

“The question now is how far this will spread. I’m looking at the spread between Italian and German bonds.”

In the table below we can see that this situation is still contained in regards to Italy & Spain, but looking increasingly ominous for Portugal & Ireland;

But what if Greece did eventually default, most likely in a managed fashion? Andrew Garthwaite at Credit Suisse maintains in his latest Global equity strategy note;

“If there is a voluntary default in Greece, there needs to be a huge IMF/EU backstop for the rest of peripheral Europe in order to avoid contagion.”

Gary Jenkins at Evo Securities notes that at that point, the fiscal deficits and debt ratios cease to matter;

“However if Greece were to restructure its debt then the actual economic numbers probably become less important for other countries than the potential reduction of confidence which could have a major impact upon sovereigns ability to borrow.”

Felix Salmon at Reuters is a bit more apocalyptic;

“Where would Greek debt trade in the event of a default? This is the scariest thing: my highly plugged-in companions both agreed that it wouldn’t just fall to 70 or even 60 cents on the dollar: they saw fair value closer to 40, and said that it would probably fall to 30 before people started buying.Needless to say, if Greek debt was trading at 30 cents on the dollar, it wouldn’t take long for the Portuguese domino to topple. After that, Spain — and then, it’s easy to imagine, Italy, Ireland, UK. And so the stakes are very high”

And finally, Harvinder Sian, a senior bond strategist at Royal Bank of Scotland in London, wrote in a note today;

“As long as Greece does not restructure then Irish paper remains very good value. If they restructure, then all the periphery is toast.”

So upon a managed (or God forbid unmanaged) default by Greece the consequences are clear for the PIIGS. How then, would this affect the banking sector? Would there indeed be bank runs?

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April 30, 2010

Greece - The End of the Beginning

Banking Troubles

The first sign of stress in the banking system has shown up, as usual, in the CDS market. The key realisation here is that, without a credible government guarantee, the interbank lending market shuts

down, and depositors don’t wait for their country or bank to go bankrupt - they immediately withdraw their deposits.

Indeed as John Mauldin of Millennium Wave Investments recently noted;

“Money is flying from Greek banks, which makes sense, as how can a bankrupt Greek government guarantee Greek bank deposits? I know that Greek bankers may have a different view, but Greek depositors are voting with their feet. And …it is not just Greece. It is fast becoming Portugal. And Spain is not far behind in my opinion.”

Moody Rating Agency, always behind the curve, took action today;

“Moody’s Investors Service has today downgraded the bank financial strength ratings (BFSRs) as well as the deposit and debt ratings of nine Greek banks”

Banks are then in trouble on 2 fronts. First, depositors flee banks in weak Eurozone member states (PIIGS) and redeposit money in stronger Eurozone countries (Germany, Netherlands). Secondly, and more interestingly, banks’ instant loss of regulatory capital, once thought to be risk free, upon default causes virtual instant insolvency!

The problem is highlighted here by Bloomberg;

“JPMorgan Chase & Co., the second- biggest U.S. bank by assets, has a larger exposure than any of its peers to Portugal, Italy, Ireland, Greece and Spain, according to Wells Fargo & Co.

JPMorgan’s exposure to the five so-called PIIGS countries is $36.3 billion, equating to 28 percent of the firm’s Tier-1 capital, a measure of financial strength, Wells Fargo analysts including Matthew Burnell wrote today. Morgan Stanley holds $32.4 billion of debt in the region, which equates to 69 percent of its Tier 1 capital, Burnell wrote.”

Buttonwood, from the Economist, puts it rather succinctly:

“The link is the banks. When we ask banks to hold capital, that usually means government debt, on the grounds that it is "risk-free". But it is pretty ridiculous to describe Greek debt as risk-free at the monment (according to Bloomberg, the two-year bonds were yielding 25% this morning). So a problem for Greece is a problem for its banks, which were indeed downgraded by S&P yesterday. And a problem for one set of European banks will be a problem for the others.

Indeed, the main incentive for other European nations in rescuing Greece is not about protecting the reputation of the euro as in preserving the banking system. This illustrates the weird symbiosis in which the governments rescued the banks but then rely on the banks to buy a large portion of their debt; two drunks propping up each other.”

Finally, in a move that shown real signs of incipient panic, the US Federal Reserve Bank appears to have reopened USD swap lines to ECB, last used in March 2009 to calm a global financial meltdown. Last time they swaped around $600 billion. This move gives the ECB the power to lend USD in Europe, and would only be re-instated if conditions were indeed deteriorating.

So we can see now why panic starts to grip the financial markets if indeed Greece may default, or if indeed any OECD member country even hints at defaulting.

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Greece - The End of the Beginning

Leaving the Eurozone

But then the real question becomes, given some from of default is unavoidable, what would it take for Greece to leave the Eurozone?

Paul Krugman, in an article for the NYT titled “How Reversible Is The Euro?”, begins to think the unthinkable;

“For a long time my view on the euro has been that it may well have been a mistake, but that bygones were bygones - it could not be undone. I was strongly influenced by the view expressed by Barry Eichengreen in a classic 2007 article: as Eichengreen argued, any move to leave the euro would require time and preparation, and during the transition period there would be devastating bank runs. So the idea of a euro breakup was a non-starter.

But now I’m reconsidering, for a simple reason: the Eichengreen argument is a reason not to plan on leaving the euro — but what if the bank runs and financial crisis happen anyway? In that case the marginal cost of leaving falls dramatically, and in fact the decision may effectively be taken out of policymakers’ hands.

Actually, Argentina’s departure from the convertibility law had some of that aspect. A deliberate decision to change the law would have triggered a banking crisis; but by 2001 a banking crisis was already in full swing, as were emergency restrictions on bank withdrawals. So the infeasible became feasible.”

Indeed, those curious should read the section at the end titled - The Argentina Scenario. It is not pretty. The thing is, the Economist agrees with Krugman;

“The trouble is that Mr Krugman is right: from the Greek perspective a euro departure begins making a lot of sense. If you're going to be saddled with the bank runs and crisis, you may as well get devaluation to go with it. I'm not sure that over the long-term life outside the euro will be better for Greece (and it's hard to imagine them ever getting back in), but politicians tend not to make decisions based on the long-term. So what do you do when Greece indicates that maybe it wants to leave the euro (particularly when a lot of Germans would be happy to see them go, damn the consequences).”

The key here will be the Greek public’s capacity for financial pain & austerity. If they take their medicine, they will remain in the Eurozone. If they revolt, all is lost.

EUR prognosis

So, where does this leave the Euro? The situation is not good. In the short run, as RBS puts it;

“For the EUR, this remains a no-win situation.”

If governments choose to go down the route of permanent bailouts for PIIGS members who get into funding difficulty, funded by the core Eurozone countries of Germany & France, then we would see a combination of Bund (German Government Bond) yields going wider (Bund prices lower) and EUR weakness. This is because the risk of PIIGS defaulting would then be subsumed by the core, and the markets would punish them accordingly.

Indeed the market seems to be moving, in an orderly fashion, away from the EUR in favour of the USD recently in anticipation of this.

Also, interestingly, the EUR, along with every major currency, is losing steady ground against gold.

This is either a sign of looming inflation or serious trouble ahead.

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Greece - The End of the Beginning

EUR prognosis cont’d

But is this EUR weakness unavoidable? I do not believe so. Consider what would happen if, as I feel likely, another PIIGS member gets into difficulty, I cannot see how politically Germany will be able to assist. There would be a severe public backlash, and no political support. This would be akin to the situation in 2008 when the US government initially rescued Bear Stearns investment bank but then could not bring itself to rescue Lehman Brothers, due to the moral hazard and political consequences involved. It is in this situation, that we could see an initial rout of the EUR vs every major currency, a Eurozone breakup with the weaker PIIGS expelled, and a return to a hard currency union under the Bundesbank, which would immediately be the strongest currency in the world, the new Deutsche Mark. This is all speculation however, as we are a long way from a Eurozone breakup yet.

Arrogance & Ignorance Personified

Finally, should you believe your politicians or bankers? NO! Just look at their record!

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”Chairman Ben S. Bernanke, US Fed, March 28, 2007

"We'd rather die than raise equity," Mr Eugene Sheehy, CEO of AIB, October 23, 2008

“There is no bailout problem… Greece will not default. In the euro area, default does not exist.” EU Monetary Affairs Commissioner Joaquin Almunia, World Economic Forum, January 29, 2010

“No, the other situations have absolutely nothing to do with that of Greece... So there’s no need to worry about the extension of this crisis.”Christian Noyer, ECB, April 24, 2010

“The euro is a stable currency and countries in the Eurozone are ready to defend it”German Finance Minister Wolfgang Schaeuble, April 23, 2010

Don’t believe a word they say! They are trying to keep a broken system together. Take measures to protect your wealth. Read the following section on Argentina to find out what happens in the absolute worst case scenario. Do you live in a PIIGS country? Are you prepared?

The Argentina Scenario

See “Will Greece repeat Argentina's 2001 fiasco?” - Market Watch - Feb. 20, 2010

In 1999, the Argentine economy entered into a severe recession that coincided with various recessions and financial crises around the world, a state of affairs that exacerbated the problems in Argentina.

A series of multi-billion-dollar financial "rescue packages" orchestrated by the IMF, World Bank, and the U.S. Treasury -- all of which involved financing to roll over the existing stock of debt and to finance new deficits, in exchange for various austerity measures including spending cuts and tax increases -- culminated in full-blown financial panic, economic depression, social emergency, and political crisis in the 2001-2002 period. The crisis took nearly 3 years to reach its nadir.

The following charts illustrate the path to total economic collapse.

Argentine Inflation 1995 - 2009

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The Argentina Scenario cont’d

In the year before the bond default in December 2001 and ending in late 2003, CPI inflation increased from -4% deflation to 120% inflation on an annual basis.

The Argentine peso, un-pegged from the U.S. dollar, collapsed by 73% in a few months, and over the next two years inflation wiped out savings and erased all debts.

Argentine Exchange Rates 1995 - 2009

The bond market disintegrated.

Argentine Bond Market 1995 - 2009

All government debt and currency crises are rooted in runaway fiscal deficits. Each nation has its own threshold, depending on trade balance, size and composition of external debt, currency reserves, and other factors. Argentina’s threshold in 2001 was 3% of GDP. Greece currently has a deficit of 14%.

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The Argentina Scenario cont’d

Now, the similarities to Greece are stunning.

1. Hard currency regime where officials had no control of monetary policy. Leading up to the crisis Argentina was operating under a "hard currency" monetary regime (a currency board that guaranteed convertibility from pesos to dollars on a 1:1 ratio) that had been adopted a decade earlier. Similarly, Greece adopted the Euro approximately a decade ago, surrendering all control of monetary policy.

2. Ingrained culture of fiscal indiscipline. Prior to adoption of the hard currency regime, Argentina had been a nation characterized, from its very inception at independence, by its fiscal indiscipline. The Greek culture of fiscal indiscipline, prior to the inception of the euro, is virtually identical to that of Argentina.

3. Fiscal indiscipline wasn't sufficiently reigned in after submitting to inflexible monetary regime.Because debt couldn't be paid for by printing money and devaluing the currency, the new currency regime required strict fiscal discipline. This didn't occur and the national debt of Argentina skyrocketed during the decade leading up to the crisis. Ditto for Greece.

4. Currency overvaluation. Adoption of the hard currency regime initially spurred massive inflows of foreign direct investment and hot money inflows. This excess liquidity (which monetary authorities couldn't control) increased currency in circulation. Furthermore, as alluded to above, government spending grew at an extremely rapid pace, and this pro-cyclical deficit spending contributed greatly to demand-side economic overheating. Consequently, internal inflation grew at a rate far greater than that of Argentina's trading partners. Over time, this situation produced a massive real exchange rate (REER) overvaluation of the currency in purchasing power parity (PPP) terms. This, in turn, reduced the nation's trade competitiveness, producing massive and structural current account deficits. This situation experienced in Argentina in the decade leading up to their crisis is virtually identical to the Greek situation leading up to the current crisis.

5. Monetary astringency. Due to unsustainable fiscal policies and an unsustainable current account situation, foreign direct investment and hot money inflows suddenly waned and/or reversed. Government officials had no way to counteract this contraction in the monetary supply and spike in interest rates. This situation experienced by Argentina is currently being faced in Greece.

6. Untenable dilemma: Deflation or abandon currency regime. Under the hard currency regime, the only way for Argentina to regain trade competitiveness was to undergo a painful deflation that would alleviate the REER currency overvaluation in PPP terms. This is precisely the situation currently faced by Greece.

7. "Rescue package" deepens crisis. From 1999 thru 2001, Argentina entered into a series of agreements with the IMF and the World Bank. The agreements required Argentina to cut spending and raise taxes in exchange for promises of financing to roll over debt and to pay for limited deficits. Such measures deepened the economic contraction causing a collapse in tax receipts and a ballooning of fiscal deficits. Each agreement with the IMF and World Bank was broken in quick succession. Finally, the U.S. Treasury stepped in and provided bilateral aid in the form of another massive financing package in exchange for deficit reduction. Again, the resulting economic contraction caused tax receipts to fall and Argentina was soon in breach of its covenants.

8. Fraud to mask breaches. The Argentine government engaged in various cover-ups in order to avoid publicly falling into breach of their covenants. When these cover-ups were unmasked, a loss of confidence by investors ensued, causing a rise in interest rates and complicating the task of obtaining financing. A virtually identical situation has occurred in Greece.

9. Large sectors of the population unwilling to sacrifice; ready and able to mobilize against regime.In Argentina, populist and nationalist groups railed against the terms of the austerity plans. As the recession worsened, massive violent demonstrations erupted. The government fell. Then another government fell. Financial panic ensued, making the recession even worse. In Greece, there is every indication that much of the population is unwilling to undergo the hardships implied by an austerity program.

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Conclusion

We certainly do live in interesting times. It is essential that each and every one of us inform ourselves and try to see how we arrived at this situation. Only then can we how to learn the correct lessons from crisis such as these.

It is also essential to take measures to protect yourself from possible economic chaos. You CANNOT rely on government. I can offer advice, but in the end each persons situation is different. Feel free to contact me anytime, and I’ll do my best to help you out.

I will leave you with a timeless truth from economist & philosopher Ludwig Van Mises;

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

Regards,

Oisin